National Penn Bancshares (NPBC) 10-K 2005 FY Annual report

UNITED STATES

SECURITIES AND EXCHANGE COMMISSION

Washington, D.C. 20549

FORM 10-K

[X]ANNUAL REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934

For the fiscal year ended

December 31, 2005

or

[X]TRANSITION REPORT PURSUANT TO SECTION 13 or 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934

For the transition period from __________ to __________.

Commission file #000-22537-01

Pennsylvania	23-2215075
(State or other jurisdiction of incorporation or organization)	(I.R.S. Employer Identification No.)
Philadelphia and Reading Avenues	19512
Boyertown, Pennsylvania	(Zip Code)
(Address of principal executive offices)

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

Securities registered pursuant to Section 12(b) of the Act: None

Securities registered pursuant to Section 12(g) of the Act:

Common Stock (without par value)

Guarantee (7.85% Preferred Securities of NPB Capital Trust II)

Preferred Stock Purchase Rights

7.85% Junior Subordinated Debentures

Indicate by check mark if the registrant is a well-known seasoned issuer, as defined in Rule 405 of the Securities Act. Yes [x] No [ ]

Indicate by check mark if the registrant is not required to file reports pursuant to Section 13 or Section 15(d) of the Exchange Act. Yes [ ] No [x]

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 if disclosure of delinquent filers pursuant to Item 405 of Regulation S-K is not contained herein, and will not be contained, to the best of Registrant’s knowledge, in definitive proxy or information statements incorporated by reference in Part III of this Form 10-K or any amendment to this Form 10-K. [X]

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

Large accelerated filer [x] Accelerated filer [ ] Non-accelerated filer [ ]

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

The aggregate market value of the voting and non-voting common equity of the Registrant held by non-affiliates, based on the closing sale price as of June 30, 2005, was $753.7 million.

As of March 3, 2006, the Registrant had 46,683,321 shares of Common Stock outstanding. Portions of the following documents are incorporated by reference: the definitive Proxy Statement of the Registrant relating to the Registrant’s Annual Meeting of Shareholders to be held on April 25, 2006 -- Part III.

NATIONAL PENN BANCSHARES, INC.

FORM 10-K

TABLE OF CONTENTS

			Page
Part I
	Item 1	Business	3
	Item 1A.	Risk Factors	21
	Item 1B.	Unresolved Staff Comments	25
	Item 2.	Properties	25
	Item 3.	Legal Proceedings	25
	Item 4.	Submission of Matters to a Vote of Security Holders	26
	Item 4A.	Executive Officers of the Registrant	26
Part II
	Item 5.	Market for Registrant’s Common Equity, Related Stockholder Matters and Issuer Purchases of Equity Securities	28
	Item 6.	Selected Financial Data	30
	Item 7.	Management’s Discussion and Analysis of Financial Condition and Results of Operations	31
	Item 7A.	Quantitative and Qualitative Disclosures About Market Risk	53
	Item 8.	Financial Statements and Supplementary Data	54
	Item 9.	Changes in and Disagreements With Accountants on Accounting and Financial Disclosure	100
	Item 9A.	Controls and Procedures	100
	Item 9B.	Other Information	100
Part III
	Item 10.	Directors and Executive Officers of the Registrant	101
	Item 11.	Executive Compensation	101
	Item 12.	Security Ownership of Certain Beneficial Owners and Management and Related Stockholder Matters	101
	Item 13.	Certain Relationships and Related Transactions	101
	Item 14.	Principal Accounting Fees and Services	101
Part IV
	Item 15.	Exhibits, Financial Statement Schedules	102
Signatures			111

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PART I

The information in this Form 10-K includes certain forward-looking statements, including statements relating to National Penn’s financial condition, results of operations, asset quality and trends in its business that involve risks and uncertainties. National Penn’s actual results may differ materially from the results discussed in these forward-looking statements. Factors that might cause such a difference include those discussed in Item 1. “Business,” Item 1A. “Risk Factors,” Item 7. “Management’s Discussion and Analysis of Financial Condition and Results of Operations”, as well as those discussed elsewhere in this Form 10-K.

Item 1. BUSINESS.

Overview

National Penn Bancshares, Inc. (“National Penn”, “Company”, or “we”) is a Pennsylvania business corporation and a registered bank holding company headquartered in Boyertown, Pennsylvania. Our address is Philadelphia and Reading Avenues, Boyertown, Pennsylvania 19512 (telephone number 610-367-6001).

National Penn was incorporated in January 1982. We provide a diversified range of financial services, principally through our national bank subsidiary, National Penn Bank. In addition, we currently conduct business through Nittany Bank (acquired in January 2006 - see “Recent Developments”) and various other direct or indirect subsidiaries. These other subsidiaries are engaged in activities related to the business of banking.

• National Penn Bank is one of the largest commercial banks headquartered in southeastern Pennsylvania. At December 31, 2005, it operated 73 community banking offices throughout nine counties in southeastern Pennsylvania and one community office in Cecil County, Maryland.

• At December 31, 2005, National Penn had total assets of $4.60 billion, total loans and leases of $3.05 billion, total deposits of $3.31 billion, and total shareholders’ equity of $444.9 million.

• For the year ended December 31, 2005, we reported record net income of $59.8 million compared to net income for the year ended December 31, 2004 of $47.9 million, an increase of 24.7%.

• As of December 31, 2005, we, together with our national bank subsidiary, National Penn Bank, had a reserve for loan and lease losses of $56.1 million, which represented 1.84% of total loans and leases outstanding of $3.05 billion.

• At the end of 2005, we experienced our twenty-eighth consecutive year of increased earnings and increased dividends.

• National Penn, together with National Penn Bank prior to formation of the bank holding company, have paid cash dividends without interruption for more than 130 years.

Recent Developments

As previously disclosed on its Form 8-K filed with the Securities and Exchange Commission on January 27, 2006, National Penn completed its acquisition of Nittany Financial Corp. (“Nittany”) and its subsidiaries, including Nittany Bank, on January 26, 2006. At the time of acquisition, Nittany had total assets, loans, deposits and shareholders’ equity of approximately $323.1 million, $279.4 million, $249.7 million and $14.2 million, respectively.

Nittany Bank is headquartered in State College, Centre County, Pennsylvania and operates four community offices in State College and one in Bellefonte, Pennsylvania. Nittany Bank is currently operating as a wholly-owned subsidiary of National Penn, and has retained its pre-acquisition management team. National Penn intends to merge Nittany Bank into National Penn Bank, and thereafter operate Nittany Bank as a division of National Penn Bank under the “Nittany Bank” name and management team. On February 10, 2006, National Penn filed an application with the Office of the Comptroller of the Currency, National Penn Bank’s primary regulator, and the Office of Thrift Supervision, Nittany Bank’s primary regulator, for approval of this proposed merger. At the date of this report, these applications are pending. No assurance can be given that these applications will be approved or as to when or on what conditions they may be approved.

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Market Area

National Penn is headquartered in Boyertown, Berks County, Pennsylvania. Boyertown is located in eastern Berks County, which strategically positions National Penn between Philadelphia to the southeast, Allentown and Bethlehem to the northeast, and Reading to the west.

We serve communities throughout southeastern Pennsylvania. Specifically, we have a nine-county market area in Pennsylvania --Berks, Bucks, Chester, Delaware, Lancaster, Lehigh, Montgomery, Northampton and Philadelphia, as well as the Cecil County, MD area. Within this geographic region, there are four distinct market areas:

• the Reading/Berks County area, an area in which the service industry is increasingly replacing the old-line manufacturing industry;

• the Allentown/Lehigh Valley area, consisting of Lehigh and Northampton Counties, also an area in which a growing service industry is replacing the old-line manufacturing industry;

• the five-county Philadelphia metropolitan area; consisting of Philadelphia and its suburbs in Bucks, Chester, Delaware and Montgomery Counties; and

• Lancaster County, an area with a significant agricultural economy.

As of January 26, 2006, we also serve the State College/Bellefonte area of Centre County, Pennsylvania, through Nittany Bank, acquired on that date. See “Recent Developments” herein.

Competition

The banking and financial services industry is extremely competitive in our market area. We face vigorous competition for customers, loans and deposits from many companies, including:

• Commercial banks;

• Savings and loan associations;

• Finance companies;

• Credit unions;

• Trust companies;

• Mortgage companies;

• Money market mutual funds;

• Insurance companies; and

• Brokerage and investment firms.

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Many of these competitors are significantly larger than National Penn; have greater resources, lending limits and larger branch systems; offer a wider array of banking services than National Penn; and are long-established in their geographic markets (some of which have only been recently entered by National Penn). See “General Development of Business” below.

In addition, some of these competitors are subject to a lesser degree of regulation than that imposed on National Penn.

Many of these competitors have elected to become financial holding companies under the Gramm-Leach-Bliley Act of 1999, including many of the largest ones. This development will likely further narrow the differences and intensify competition among commercial banks, investment banks, insurance firms and other financial services companies. See “Gramm-Leach-Bliley Act” below.

Business Strategy

Our goal is to become the most highly regarded financial institution in the markets we serve. We intend to accomplish this goal by combining the sophisticated products and fee-based services of a major regional financial services company with the personal attention, service and responsiveness of a community bank holding company. We believe this strategy results in greater profitability than a typical community bank. The primary components of our business strategy are commercial banking, consumer banking, niche marketing, development of fee income, and enhanced customer service.

Commercial Banking. Commercial banking has been our historic and ongoing business focus. Our business customers tend to be small to middle market customers with annual gross revenues generally between $1 million and $50 million who generally do not receive the attention of our larger, more nationally focused competitors. Many of these customers require us to have a high degree of understanding of their business in order for us to be able to customize solutions to their financial requirements. We believe that this helps to distinguish us from our competitors. We offer a wide range of products including short-term loans for seasonal and working capital purposes, term loans secured by real estate and other assets, loans for construction and expansion needs, revolving credit plans and sophisticated cash management services. As of December 31, 2005, our commercial loan portfolio was $2.30 billion, which represents 75.3% of our total loans outstanding.

Another important component of our commercial lending practice is our emphasis on small businesses and their unique needs. In order to serve small businesses better, National Penn Bank is an approved “SBA Preferred/Express Lender” by the U.S. Small Business Administration. Being a Preferred/Express Lender authorizes us to underwrite and approve qualifying small business loans without the prior approval of the Small Business Administration. During 2005, National Penn Bank originated over $18.7 million of loans that qualified for U.S. Small Business Administration guarantees.

Consumer Banking. We offer a full range of deposit accounts, which include demand, NOW, money market, certificates of deposit and other checking and savings accounts. We also offer consumer loan products such as installment loans, home equity loans, residential mortgage loans, multi-family loans, educational loans and credit cards. In addition, we offer automated teller services through an inter-bank automated teller system, safe deposit and night depository facilities and internet banking services, including on-line bill paying.

Niche Marketing. An important component of our business strategy is the development of business lines that give us higher margin opportunities. We are continually assessing the markets within which we operate in order to identify and seize upon opportunities where we believe a market segment is being under-served. Once identified, we focus on customizing solutions that are beneficial to the user and profitable to us.

An example is our Manufacturing Group. The Manufacturing Group, organized in 1999, is a unique lending group whose focus is on assisting manufacturing firms in solving industry-specific challenges. The Manufacturing Group is comprised of specialized teams of experienced bankers who have industry-specific training or experience and can offer an array of resources to time-challenged business owners, through the Manufacturing Group’s Solutions Network^TM- a database of National Penn professionals and other selected third-party resource providers who assist with financial and non-financial business challenges. Value-added areas include industry specific seminars, newsletters, websites and a Board of Advisors that provides feedback and support to the group. At December 31, 2005, the Manufacturing Group managed relationships with loans outstanding of approximately $136.8 million.

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Another example is our International Banking Group. The International Banking Group provides for customer import, export and general documentary credit, foreign exchange and international payment needs. As of December 31, 2005 the unit served over 430 customers with a letter of credit portfolio totaling $96.0 million. The International Banking Group has been in operation since June 2001.

A third example is our Government Banking Group, formed in 2001, which serves the unique banking needs of local government entities such as school districts, municipalities and townships. At December 31, 2005, our Government Banking Group deposits totaled $477.9 million.

Development of Fee Income. In addition to generation of fee income through our commercial banking operations, we have formed a number of specialized investment, insurance and lending subsidiaries to develop fee income and to serve specific markets.

We provide trust and investment management services through National Penn Investors Trust Company, our national trust company subsidiary. We also provide investment management services through National Penn Capital Advisors, Inc. and market brokerage services provided by PrimeVest Financial Services, Inc. through National Penn Investment Services. In total, our wealth management group manages approximately $1.65 billion for over 12,500 individual and corporate customers. We have provided securities brokerage services through a third party vendor since December 2004. Prior to December 2004, we provided securities brokerage services through a registered broker-dealer subsidiary.

We provide insurance services through National Penn Insurance Agency, Inc. National Penn Insurance Agency generated over $6.9 million in revenue in 2005, acquired three insurance agencies since June 2004, and now serves over 10,000 customers.

We conduct mortgage banking activities through National Penn Mortgage Company. National Penn Mortgage Company originated $346.6 million in residential mortgages and $5.4 million in mortgage banking income in 2005.

For the year ended December 31, 2005, our efforts produced total fee income for the Company of $57.0 million compared to $46.8 million for the year ended December 31, 2004.

Enhanced Customer Service. Our business strategy is supported by a strong delivery system that places greater emphasis on customer service. We have segmented our market into divisions based primarily on geographic considerations. Each division is managed by a division president who reports to a designated executive officer. This officer coordinates our sales and servicing efforts in order to effectively serve our current customers and gain new customers. The purpose of this initiative is to better leverage our centralized marketing and servicing efforts, thereby increasing sales of the wide range of products and services that we offer. We believe that this cross-functional approach leads to more responsive service for our customers who, in turn, reward us with more of their total financial services needs.

General Development of Business

National Penn Bank, then known as National Bank of Boyertown, was originally chartered in 1874. National Bank of Boyertown converted to a holding company structure in 1982 by forming National Penn Bancshares, Inc. as a parent company to the Bank. National Bank of Boyertown changed its name to National Penn Bank in 1993 to reflect its growing market territory.

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Since January 2001, National Penn has grown significantly. Growth has been generated both internally and through acquisitions and mergers that have either “filled in” or extended our reach into new markets. At December 31, 2000, National Penn had $2.62 billion in total assets, and National Penn Bank conducted operations through 61 community offices. At December 31, 2005, National Penn had $4.60 billion in total assets, and National Penn Bank conducted operations through 74 community offices.

The following highlights major developments in our business of the last five years:

2001. In January, we completed the acquisition of Community Independent Bank, Inc. and then merged its subsidiary, Bernville Bank, N.A., into National Penn Bank. In this transaction, National Penn Bank acquired four community offices in western Berks County, with $103 million in assets. Later during the year, we transferred the assets, liabilities and business of National Penn Bank’s National Asian Bank Division to Panasia Bank, N.A., creating a larger unified entity better able to focus on serving the Asian-American communities in northern New Jersey and southeastern Pennsylvania. Also during the year, National Penn Bank formed the Government Banking Group to serve the unique banking needs of local government entities such as school districts, municipalities and townships, and the International Banking Group to help companies enter global markets, increase their international sales and profitability and reduce the various payment risks of their international operations.

2002. In early 2002, National Penn Bank began a unified branding campaign emphasizing use of the “National Penn Bank” brand-name and phasing out the use of historically-based divisional names other than those relating to recent acquisitions. We also formed National Penn Leasing Company as a new commercial equipment leasing company. In August, we raised capital by issuing $63.25 million of 7.85% trust preferred securities. In September, we entered into an agreement to acquire FirstService Bank, a community bank headquartered in Doylestown, Bucks County, with seven community offices in Bucks and Montgomery Counties. This acquisition would substantially strengthen our retail and commercial banking presence in Bucks County, as well as strengthen our asset management and insurance agency businesses. In October, we used a portion of the net proceeds of the August trust preferred securities offering to redeem all $40.25 million of our 9% trust preferred securities issued in 1997. Later in the year, we decided to re-focus our efforts on our core southeastern Pennsylvania markets.

2003. In February, we completed the FirstService Bank acquisition, acquiring assets of $367 million, by

merging FirstService Bank into National Penn Bank. This transaction substantially increased our presence in the Bucks County marketplace. Given our decision to re-focus our efforts on our core southeastern Pennsylvania markets, in February we entered into an agreement to sell our Panasia Bank, N.A. subsidiary to Woori America Bank for $34.5 million in cash. This sale was completed in September. In April, in a market extending acquisition, we entered into an agreement to acquire HomeTowne Heritage Bank, a community bank that had $165 million in assets and four community offices located in Lancaster County, PA. We acquired HomeTowne Heritage Bank in December and merged it into National Penn Bank, strengthening our efforts to expand our business in the Lancaster County market. In December 2003, we entered into an agreement to acquire Peoples First, Inc. and its banking subsidiary, The Peoples Bank of Oxford. Peoples had assets of approximately $456 million, with eight community offices in southern Chester County and Lancaster County and one community office in Cecil County, Maryland.

2004. We completed the acquisition of Peoples First, Inc. and its banking subsidiary, The Peoples Bank of

Oxford, on June 10, 2004. This acquisition substantially strengthened our market position in southern Chester County and Lancaster County and provided us with an entry into Maryland. We also took various steps to extend use of the “National Penn” brand throughout the Company. In June 2004, we re-branded our mortgage company as “National Penn Mortgage Company”. We also began the planning process for consolidating the businesses of our wealth management subsidiaries, Investors Trust Company and FirstService Capital, Inc., together with the trust business of The Peoples Bank of Oxford, into a “National Penn”-branded entity. In connection with this reorganization, we filed an application with the OCC to convert the charter of Investors Trust Company to a limited purpose national trust company to be named “National Penn Investors Trust Company”. We also began offering securities brokerage services under the name “National Penn Investment Services” through a third party vendor in December 2004, replacing such services previously offered through our own broker-dealer subsidiary. During 2004, we took steps intended to increase our ratio of fee-based income to total revenue. These included our acquisition of two established insurance agencies, each with operations within our market area - Pennsurance, Inc., located in Oley, Berks County, PA, acquired in June 2004; and D. E. Love Associates, Inc., based in Yardley, Bucks County, PA, acquired in November 2004.

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2005. In January 2005, we acquired another established insurance agency with operations in our market area - the Krombolz Agency, Inc., based in West Chester, Chester County, Pennsylvania - and merged it into our insurance agency subsidiary, National Penn Insurance Agency, Inc. This furthered the build-out of our insurance business throughout our southeastern Pennsylvania geographic footprint. In July, we completed the consolidation of our wealth management subsidiaries into National Penn Investors Trust Company, a limited purpose national trust company, providing us with a unified entity to offer trust and investment management services. In September, we entered into an agreement to acquire Nittany Financial Corp., a holding company headquartered in State College, Centre County, Pennsylvania, whose principal subsidiary, Nittany Bank, conducts a community banking business through four community offices in State College and one community office in nearby Bellefonte. Nittany Financial also had $342 million under management at December 31, 2005 through its subsidiaries, Vantage Investment Advisors, L.L.C. and Nittany Asset Management, Inc. This acquisition, completed in January 2006, results in our entry into a strong market in central Pennsylvania, and strengthens our overall asset management business. See “Recent Developments” herein.

Lending

Underwriting and Credit Administration

Our Board of Directors has established comprehensive lending practices. Our policies require that loans meet sound underwriting criteria. A committee (Credit Policy Committee) approves loan authority for certain officers to be used individually or jointly and for various loan committees of National Penn Bank. Any loan request for an amount exceeding individual or joint approval levels must be approved by one of two credit committees. The first committee (the Commercial Credit Committee) consists of Wayne Weidner (National Penn Chairman and Chief Executive Officer), Glenn Moyer (National Penn President and National Penn Bank President and CEO), Paul McGloin (Chief Lending Officer), Garry Koch (Director of Risk Management) and Hugh Marshall (Executive Vice President and Chief Credit Officer). This committee considers commercial business loan requests and commercial real estate loan requests from $7.5 million up to $12.5 million. The second committee (the Executive Credit Committee) consists of Messrs. Weidner, Moyer, McGloin, Marshall and Koch, together with independent non-employee National Penn Bank directors John H. Body, J. Ralph Borneman, Jr., C. Robert Roth and Stratton D. Yatron. This committee considers commercial business loan requests and commercial real estate loan requests in excess of $12.5 million.

National Penn Bank originates loans through direct solicitation of the borrower, referral sources, through loan participations with other banks, loan brokers, equipment vendors, and purchases some leases through other financial institutions.

As part of our credit administration process, we have an asset quality review performed by an outside consultant. Their review consists of sampling the commercial business and commercial real estate portfolio, reviewing individual borrower files for adherence to policy and underwriting standards, proper loan administration, and asset quality. National Penn Bank’s Chairman, CEO and senior lending and credit administration personnel meet monthly to review delinquencies, non-performing assets, classified assets and other relevant information to evaluate credit risk within this portfolio. The results are then reviewed by the Directors Risk Committee, a committee of National Penn’s Board of Directors formed in 2005 to provide oversight, direction and authority to management regarding National Penn’s enterprise-wide risk management process.

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Loan Portfolio

At December 31, 2005 and 2004, our portfolio was composed of the following loan types

(dollars in thousands):

	December 2005		Percentage of Portfolio			December 2004		Percentage of Portfolio
Commercial Real Estate
Commercial Properties	$	289,432		9.49	%	$	318,873		11.09	%
Residential Subdivision		196,038		6.43			108,644		3.78
Multifamily		63,702		2.09			59,551		2.07
Commercial Business Loans
Commercial Term Loans & Mortgages		1,326,531		43.50			1,366,531		47.54
Lines of Credit		387,320		12.70			266,815		9.28
Leases		34,944		1.15			31,085		1.08
Consumer Loans
Residential Mortgages		245,260		8.04			268,157		9.33
Home Equity Loans		254,591		8.35			159,194		5.54
Home Equity Lines of Credit		233,347		7.65			200,234		6.97
Other Loans		18,643		0.60			95,355		3.32
Total Loans	$	3,049,808		100.00	%	$	2,874,439		100.00	%

Commercial Lending

General - A majority of National Penn Bank’s loan assets are loans to business owners of many types. National Penn Bank makes commercial loans for real estate development, equipment financing, account receivables and inventory financing and other purposes as required by the broad spectrum of borrowers. Commercial loans by their nature carry higher risk than loans to consumers. The changes in commercial borrowers’ financial condition and cash flow plus the potential volatility in the value of collateral held makes commercial lending a higher risk form of lending. Consequently, a greater percentage of National Penn Bank’s resources and the staff’s time are devoted to monitoring this area of the portfolio.

National Penn Bank’s credit policies determine advance rates against the different forms of collateral that can be pledged against commercial loans. Typically, loans will be limited to 85% of real estate values, 75% of new equipment, 80% against eligible accounts receivable and 50% or less against finished inventory or raw material. Individual loan advance rates may be higher or lower depending upon the financial strength of the borrower and/or the term of the loan.

Below are different loan types and descriptions offered to National Penn Bank’s commercial loan customers.

Commercial Real Estate

Commercial Properties - These loans include both construction loans and long-term loans financing commercial properties such as office buildings, retail strip malls, and medical office buildings. All properties in this category are non-owner occupied. Repayment of this kind of loan is dependent upon the resale of or lease of the subject property. Loan terms range from one year to 20 years. Interest rates can be either floating or fixed rates. Fixed rates are generally set for periods of three to seven years with either a rate reset provision or a balloon payment.

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Residential Subdivision - These loans are made to residential subdivision developers for the building of

residential properties including roadways, the installation of utilities and the actual construction of the one to four family houses. Repayment of this kind of loan is dependent upon the sale of individual houses to consumers or in some cases to other developers. Terms of the loan are generally for one to three years. Interest rates are usually floating, generally based on the Wall Street Journal prime rate plus an increment.

Multifamily - These loans provide the construction and/or long term financing of greater than five unit residential properties that are for lease. Loan terms are generally from one year to 20 years with some loans amortizing over 25 years. Interest rates can be either floating or fixed for three to 10 year periods. These loans are repaid from the lease of the individual units.

Commercial Business Loans

Loans in this general category are made to proprietors, professionals, partnerships and corporations. Repayment of this kind of loan generally comes from the cash flow of the business. The assets financed are used within the business for its ongoing operation.

Commercial Term Loans and Mortgages - These loans are typically used to finance the equipment and the owner-occupied real estate needs of the borrower. Terms will range from 3 to 25 years dependent upon the economic life of the asset financed. Interest rates will be either floating or fixed for periods up to 10 years. Many loans, although written with extended amortizations, will actually require balloon payments at 3, 5, or 10 years.

Commercial Lines of Credit - As of December 31, 2005, National Penn Bank had lines of credit representing

$988.8 million in commitments to business owners. The lines finance short-term working capital needs of the borrower including funds for accounts receivable, inventory, short-term equipment needs and operating expenses. Lines of credit allow the business owner to borrow, repay, and re-borrow funds on an as needed basis up to a pre-determined maximum level. Lines of credit are typically committed for one year but may be granted for longer terms based on the financial strength of the borrower and the collateral provided. Typical collateral for a line of credit will consist of the borrower’s accounts receivable, inventory, machinery and equipment. Sometimes the collateral will include the business real estate or the business owner’s personal residence. Repayment of the line is dependent upon the ongoing success of the business and the conversions of assets, such as accounts receivable and inventory, to cash. Interest rates are usually floating and are generally based on Wall Street Journal Prime rate, or the 30 day London InterBank Offered Rate (LIBOR).

National Penn Bank is a preferred lender as designated by the U.S. Small Business Administration (SBA). As such, National Penn Bank originates loans to business owners that qualify for a loan guaranty issued by the SBA. The amount of the guaranty can range from 50% to 85% of the loan amount dependent on the form of the loan. SBA guaranteed loans may be used to finance equipment, owner-occupied business real estate, accounts receivables and inventory. The term of SBA loans can range from a few months up to 20 years dependent upon the purpose and collateral offered. SBA regulations limit interest rates and terms. In calendar year 2005 National Penn Bank originated $18.7 million SBA guaranteed loans, down slightly from $18.9 million originated in 2004. The Bank actively sells the guaranteed portion of these loans in the secondary market.

Leasing - National Penn Bank makes lease financing available to business customers through its wholly owned subsidiary, National Penn Leasing Company (NPLC). NPLC provides leases for many types of equipment, serving the manufacturing, service, transportation and construction sectors. Leases are written at fixed rates for 3 to 7 year terms based on the economic life of the underlying equipment. Leases can be capital leases, operating leases, conditional sales contracts or other lease structures dependent on the financial condition and needs of the lessee as well as the type of equipment involved. NPLC started business in December 2002 and at December 31, 2005, had total leases outstanding of $34.9 million.

Consumer Lending

General - National Penn Bank provides loans to consumers to finance personal residences, automobiles, college tuition, home improvements and other personal needs. Through its subsidiary, Penn 1^st Financial Services, Inc. (operating under the trade name “National Penn Mortgage Company”), National Penn Bank originates first lien residential mortgages throughout southeastern Pennsylvania, New Jersey, Maryland, Virginia, North Carolina and South Carolina. In 2005, National Penn Mortgage Company originated $337.2 million in first lien residential mortgages up from $247.3 million in 2004. In 2005, the Company also originated $9.4 million in second lien home equity loans. All of these residential mortgages are sold to secondary market investors or held within National Penn Bank’s investment or loan portfolios. At year-end 2005, the residential mortgages held in National Penn Bank’s loan portfolio totaled $245.3 million compared to $268.2 million as of December 31, 2004.

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National Penn Bank also provides home equity loans, home equity lines of credit and other consumer loans through its network of community offices and Private Banking division. The majority of National Penn Bank’s consumer loans are secured by the borrower’s residential real estate in either a first or second lien position. National Penn Bank requires a loan to value ratio of not greater than 80% on this portfolio with some exceptions based on the borrower’s financial strength. National Penn Bank originates all of its home equity loans and home equity lines of credit directly with its customers. National Penn Bank has a small indirect loan portfolio in which the transactions are initiated through a third party, generally an auto dealer or equipment vendor, and subsequently funded by National Penn Bank. This “indirect” loan portfolio had total loans outstanding at December 31, 2005, of $3.4 million.

Investment Policies and Strategies

The investment portfolio includes the National Penn Bank portfolio and the National Penn Investment Company portfolio. The National Penn Bank portfolio totaled $1.05 billion at December 31, 2005 and $1.15 billion at December 31, 2004. The investment company portfolio was $39.2 million at December 31, 2005 and $41.2 million at December 31, 2004. At December 31, 2005, National Penn Investors Trust Company had a small investment portfolio of $3.2 million as a vehicle to invest its capital. The decrease in the bank’s investment portfolio from 2004 to 2005 was the result of using some of the cash flow from the portfolio to help fund our liquidity needs during the year.

National Penn Bank’s investment portfolio consists primarily of Agency and Municipal bonds. The Agency bonds include debentures as well as mortgage-backed securities issued by GNMA, FNMA and FHLMC. Agency and municipal bonds carry low risk-based capital requirements. The primary purpose of the Bank investment portfolio is to provide a secondary source of liquidity, and the secondary purpose is to provide a source of income. With liquidity as the primary focus, we concentrate on buying high quality, highly marketable securities. We also construct the portfolio to provide a steady cash flow stream. Virtually all of the National Penn Bank investment portfolio supports our funding pledging needs (that is, we must pledge qualifying assets to secure deposits of municipalities and other governmental entities). In addition to the factors discussed, we follow a strategy of shortening the duration of the Bank portfolio when rates are low and lengthening the duration of the investment portfolio when rates are high. Interest rates increased steadily during 2005, so we became more comfortable purchasing longer-term investments later in the year. Whether we are buying shorter-term securities during low rate cycles, or longer-term securities during times of higher rates, we consider the impact of the investment portfolio in the Company’s overall interest rate risk position. We therefore might adjust this strategy, due to our need to remain consistent with our interest rate risk corporate guidelines.

In 2004 and 2003, we pooled our own production of ten and fifteen year fixed rate mortgage loans and converted the loans to FHLMC securities in order to transfer assets to the investment portfolio. This is a more price-efficient way to add mortgage-backed securities to our portfolio as compared to purchasing mortgage-backed securities in the secondary market. These loans, when securitized, are more liquid and also support our deposit pledging needs. There were no securitizations in 2005.

National Penn Investment Company’s portfolio consists primarily of investments in regional or community banking organizations. These investments are in the form of common stock or trust preferred securities. The primary purpose of this portfolio is to generate income, including both current income in the form of interest and dividends, as well as long-term capital gains. The common stock is readily marketable, but there is not an active secondary market in the trust preferred securities. Our strategy in the trust preferred portfolio is to invest in other banks where we can understand the financial performance and risks involved, while enjoying a higher return. These investments require the same risk-based capital as commercial loans, but the overall dollar amount of this portfolio, at $21.6 million, is relatively small so the impact on capital is not material.

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Operating Segments

National Penn has one reportable segment, Community Banking, and certain other non-reportable segments, as described in Footnote 20 of the Notes to Consolidated Financial Statements included at Item 8 of this Report. Footnote 20 includes segment information on revenue, assets and income, and is incorporated by reference in this Item 1.

Products and Services with Reputation Risk

National Penn and its subsidiaries offer a diverse range of financial and banking products and services. In the event one or more customers and/or governmental agencies becomes dissatisfied or objects to any product or service offered by National Penn or any of its subsidiaries, negative publicity with respect to any such product or service, whether legally justified or not, could have a negative impact on National Penn’s reputation. The discontinuance of any product or service, whether or not any customer or governmental agency has challenged any such product or service, could have a negative impact on National Penn’s reputation.

Future Acquisitions

Our acquisition strategy consists of identifying financial service companies, including banks, insurance agencies and investment advisers, with business philosophies that are similar to ours, which operate in strong markets, and which can be acquired at an acceptable cost. In evaluating acquisition opportunities, we generally consider potential revenue enhancements and operating efficiencies, asset quality, interest rate risk, and management capabilities. We currently have no formal commitments with respect to future acquisitions, although discussions with acquisition candidates take place frequently.

Concentrations, Seasonality

We do not have any portion of our businesses dependent on a single or limited number of customers, the loss of which would have a material adverse effect on our business. No substantial portion of investments are concentrated within a single industry or group of related industries. The Company’s commercial loan portfolio has a concentration in loans to commercial real estate investors and developers and a significant amount of loans are secured by real estate located in southeastern Pennsylvania. See also “Significant Concentrations of Credit Risk” in Footnote 1 to the Consolidated Financial Statements included at Item 8 of this Report. While our businesses are not seasonal in nature, we experience some fluctuation in our deposits due to the seasonality of government and school district deposits. See “Liquidity and Interest Rate Sensitivity” in Item 7 of this Report.

Environmental Compliance

Our compliance with federal, state and local environmental protection laws had no material effect on capital expenditures, earnings or our competitive position in 2005, and is not expected to have a material effect on such expenditures, earnings or competitive position in 2006.

Employees

At December 31, 2005, National Penn and its subsidiaries had 1,247 full- and part-time employees.

Website Availability of Reports

We maintain a website at: www.nationalpennbancshares.com. We make our Forms 10-K, 10-Q and 8-K (and amendments to each) available on this website free of charge at the same time as those reports are filed with the SEC (or as soon as reasonably practicable following that filing).

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Supervision and Regulation

Bank holding companies and banks operate in a highly regulated environment and are regularly examined by federal and state regulatory authorities.

The following discussion concerns various federal and state laws and regulations and the potential impact of such laws and regulations on National Penn and its subsidiaries.

To the extent that the following information describes statutory or regulatory provisions, it is qualified in its entirety by reference to the particular statutory or regulatory provisions themselves. Proposals to change laws and regulations are frequently introduced in Congress, the state legislatures, and before the various bank regulatory agencies. National Penn cannot determine the likelihood or timing of any such proposals or legislation or the impact they may have on National Penn and its subsidiaries. A change in law, regulations or regulatory policy may have a material effect on the business of National Penn and its subsidiaries.

Bank Holding Company Regulation

National Penn is registered as a bank holding company under the Bank Holding Company Act of 1956, as amended (“BHCA”) and is subject to inspection, examination and supervision by the Board of Governors of the Federal Reserve System (the “Federal Reserve”).

In general, the BHCA limits the business in which a bank holding company may engage to banking, managing or controlling banks and other activities that the Federal Reserve determines to be appropriately incidental to the business of banking. The Gramm-Leach-Bliley Act of 1999 (“GLBA”) amended the BHCA and established a new kind of bank holding company called a “financial holding company.” GLBA expanded the permissible activities of a bank holding company that elects to become a financial holding company. A financial holding company may engage in any type of financial activity. Although National Penn believes that it is eligible to do so, National Penn has not elected to become a “financial holding company.” See “Gramm-Leach-Bliley Act” below.

Bank holding companies are required to file periodic reports with and are subject to examination by the Federal Reserve. Federal Reserve regulations require a bank holding company to serve as a source of financial and managerial strength to its subsidiary banks. Pursuant to these “source of strength” regulations, the Federal Reserve may require National Penn to commit its resources to provide adequate capital funds to National Penn Bank during periods of financial stress or adversity. This support may be required at times when National Penn is unable to provide such support. Any capital loans by National Penn to National Penn Bank would be subordinate in right of payment to deposits and certain other indebtedness of National Penn Bank.

If any insured depository institution subsidiary of a bank holding company becomes “undercapitalized” (as defined by regulations) and is required to file a capital restoration plan with its appropriate federal banking agency, the Federal Deposit Insurance Act (“FDIA”) requires a bank holding company to guarantee the depository institution’s compliance with its capital restoration plan, up to specified limits.

The BHCA gives the Federal Reserve the authority to require a bank holding company to terminate any activity or relinquish control of a nonbank subsidiary (other than a nonbank subsidiary of a bank) upon the Federal Reserve’s determination that such activity or control constitutes a serious risk to the financial soundness and stability of any bank subsidiary of the bank holding company.

The BHCA prohibits National Penn from acquiring direct or indirect control of more than 5% of the outstanding shares of any class of voting stock or substantially all of the assets of any bank, or merging or consolidating with another bank holding company, without prior approval of the Federal Reserve. Such a transaction may also require approval of the Pennsylvania Department of Banking. Pennsylvania law permits Pennsylvania bank holding companies to control an unlimited number of banks.

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The BHCA further prohibits National Penn from engaging in or from acquiring ownership or control of more than 5% of the outstanding shares of any class of voting stock of any company engaged in a nonbanking business unless such business is determined by the Federal Reserve, by regulation or by order, to be so “closely related to banking” as to be a “proper incident” thereto. The BHCA does not place territorial restrictions on the activities of such nonbanking-related businesses.

The Federal Reserve’s regulations concerning permissible nonbanking activities for National Penn provide fourteen categories of functionally related activities that are permissible nonbanking activities. These are:

• Extending credit and servicing loans.

• Certain activities related to extending credit.

• Leasing personal or real property under certain conditions.

• Operating nonbank depository institutions, including savings associations.

• Trust company functions.

• Certain financial and investment advisory activities.

• Certain agency transactional services for customer investments, including securities brokerage activities.

• Certain investment transactions as principal.

• Management consulting and counseling activities.

• Certain support services, such as courier and printing services.

• Certain insurance agency and underwriting activities.

• Community development activities.

• Issuance and sale of money orders, savings bonds, and traveler’s checks.

• Certain data processing services.

Depending on the circumstances, Federal Reserve approval may be required before National Penn or its nonbank subsidiaries may begin to engage in any such activity and before any such business may be acquired.

Dividend Restrictions

National Penn is a legal entity separate and distinct from National Penn Bank and National Penn’s other direct and indirect nonbank subsidiaries.

National Penn’s revenues (on a parent company only basis) result almost entirely from dividends paid to National Penn by its subsidiaries. The right of National Penn, and consequently the right of creditors and shareholders of National Penn, to participate in any distribution of the assets or earnings of any subsidiary through the payment of such dividends or otherwise is necessarily subject to the prior claims of creditors of the subsidiary (including depositors, in the case of National Penn Bank), except to the extent that claims of National Penn in its capacity as a creditor may be recognized.

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Federal and state laws regulate the payment of dividends by National Penn’s subsidiaries. See “Supervision and Regulation - Regulation of National Penn Bank” in this Item 1. See also Footnote 18 to the Consolidated Financial Statements included at Item 8 of this Report.

Further, it is the policy of the Federal Reserve that bank holding companies should pay dividends only out of current earnings. Federal banking regulators also have the authority to prohibit banks and bank holding companies from paying a dividend if the regulators deem such payment to be an unsafe or unsound practice.

Capital Adequacy

Bank holding companies are required to comply with the Federal Reserve’s risk-based capital guidelines. Capital adequacy guidelines involve quantitative measures of assets, liabilities and certain off-balance sheet items calculated under regulatory accounting practices. Capital amounts and classifications are also subject to qualitative judgments by regulators about components, risk weighting and other factors. Capital adequacy guidelines are intended to ensure that bank holding companies have adequate capital given the risk levels of its assets and off-balance sheet financial instruments. The guidelines require that bank holding companies maintain minimum ratios of capital to risk-weighted assets. For purposes of calculating the ratios, a bank holding company’s assets and some of its specified off-balance sheet commitments and obligations are assigned to various risk categories and its capital is classified in one of three tiers.

The required minimum ratio of total capital to risk-weighted assets (including certain off-balance sheet activities, such as standby letters of credit) is 8%. At least half of total capital must be “Tier 1 capital”. Tier 1 capital consists principally of common shareholders’ equity, retained earnings, a limited amount of qualifying perpetual preferred stock and minority interests in the equity accounts of consolidated subsidiaries, less goodwill and certain intangible assets. The remainder of total capital may consist of mandatory convertible debt securities and a limited amount of subordinated debt, qualifying preferred stock and loan loss allowance (“Tier 2 capital”). At December 31, 2005, National Penn’s Tier 1 capital and total (Tier 1 and Tier 2 combined) capital ratios were 10.47% and 11.81%, respectively.

In addition to the risk-based capital guidelines, the Federal Reserve requires a bank holding company to maintain a minimum “leverage ratio”. This requires a minimum level of Tier 1 capital (as determined under the risk-based capital rules) to average total consolidated assets of 3% for those bank holding companies that have the highest regulatory examination ratings and are not contemplating or experiencing significant growth or expansion. The Federal Reserve expects all other bank holding companies to maintain a ratio of at least 1% to 2% above the stated minimum. At December 31, 2005 National Penn’s leverage ratio was 8.36%.

The Federal Reserve has also indicated that it will consider a “tangible Tier 1 capital leverage ratio” (deducting all intangibles) and other indicators of capital strength in evaluating proposals for expansion or new activities. The Federal Reserve has not advised National Penn of any specific minimum leverage ratio applicable to National Penn.

The FDIA requires an insured institution to take “prompt corrective action” in the event minimum capital requirements are not met. Pursuant to the “prompt corrective action” provisions of the FDIA, the federal banking agencies have specified, by regulation, the levels at which an insured institution is considered “well capitalized”, “adequately capitalized”, “undercapitalized”, “significantly undercapitalized”, or “critically undercapitalized.”

Under these regulations, an institution is considered “well capitalized” if it satisfies each of the following requirements:

• It has a total risk-based capital ratio of 10% or more

• It has a Tier 1 risk-based capital ratio of 6% or more

• It has a leverage ratio of 5% or more.

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• It is not subject to any order or written directive to meet and maintain a specific capital level.

At December 31, 2005, National Penn Bank qualified as “well capitalized” under these regulatory standards. See Footnote 18 of the Notes to Consolidated Financial Statements included at Item 8 of this Report.

FDIC Insurance Assessments

National Penn Bank is subject to deposit insurance assessments by the Federal Deposit Insurance Corporation (“FDIC”). These assessments fund both the Bank Insurance Fund (“BIF”) for banks and the Savings Association Insurance Fund (“SAIF”) for savings associations. The assessments are based on the risk classification of the depository institutions. National Penn Bank was not subject to any regular insurance assessments by the FDIC in 2005. Under current FDIC practices, National Penn Bank does not expect to be required to pay regular insurance assessments to the FDIC in 2006.

In 1996, the SAIF was recapitalized. As part of the recapitalization, both BIF-insured deposits and SAIF-insured deposits are now assessed to fund debt service on the Federal government’s related bond payments. The current annualized rate established by the FDIC for both BIF-insured deposits and SAIF-insured deposits is $.017 per $100 of deposits. These bonds mature in 2017.

Regulation of National Penn Bank

The operations of National Penn Bank are subject to federal and state statutes applicable to banks chartered under the banking laws of the United States, to members of the Federal Reserve System, and to banks whose deposits are insured by the FDIC. The operations of National Penn Bank are also subject to regulations of the Office of the Comptroller of the Currency (“OCC”), the Federal Reserve, and the FDIC.

The OCC, which has primary supervisory authority over National Penn Bank, regularly examines banks in such areas as reserves, loans, investments, management practices and other aspects of operations. These examinations are designed for the protection of depositors rather than National Penn’s shareholders. The bank must furnish annual and quarterly reports to the OCC, which has the legal authority to prevent a national bank from engaging in an unsafe or unsound practice in conducting its business.

Federal and state banking laws and regulations govern, among other things, the scope of a bank’s business, the investments a bank may make, the reserves against deposits a bank must maintain, the types and terms of loans a bank may make and the collateral it may take, the activities of a bank with respect to mergers and consolidations, and the establishment of branches, including community offices. Pennsylvania law permits statewide branching.

Under the National Bank Act, National Penn Bank is required to obtain the prior approval of the OCC for the payment of dividends if the total of all dividends declared by it in one year would exceed its net profits for the current year plus its retained net profits for the two preceding years, less any required transfers to surplus. In addition, National Penn Bank may only pay dividends to the extent that its retained net profits (including the portion transferred to surplus) exceed statutory bad debts. Under the FDIA, National Penn Bank is prohibited from paying any dividends, making other distributions or paying any management fees if, after such payment, it would fail to satisfy its minimum capital requirements.

As a subsidiary bank of a bank holding company, National Penn Bank is subject to certain restrictions imposed by the Federal Reserve Act on extensions of credit to the bank holding company or its subsidiaries, on investments in the stock or other securities of the bank holding company or its subsidiaries, and on taking such stock or securities as collateral for loans.

The Federal Reserve Act and Federal Reserve regulations also place certain limitations and reporting requirements on extensions of credit by a bank to the principal shareholders of its parent holding company, among others, and to related interests of such principal shareholders. In addition, such legislation and regulations may affect the terms upon which any person becoming a principal shareholder of a holding company may obtain credit from banks with which the subsidiary bank maintains a correspondent relationship.

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Regulation of Nittany Bank

Nittany Bank, acquired by National Penn on January 26, 2006, is a federal stock savings bank. Its deposits are insured by the Savings Association Insurance Fund of the FDIC. Nittany Bank is subject to extensive regulation by the Office of Thrift Supervision (“OTS”) and the FDIC. Nittany Bank is also subject to certain reserve requirements promulgated by the Federal Reserve.

Subject to receipt of required regulatory approvals, National Penn intends to merge Nittany Bank with and into National Penn Bank in 2006, at which time, it will cease to be regulated as a separate entity.

Regulation of Other Subsidiaries

National Penn’s direct nonbank subsidiaries are subject to regulation by the Federal Reserve. In July 2005, National Penn converted Investors Trust Company from a state-chartered trust company regulated by the Federal Reserve and the Pennsylvania Department of Banking to a limited purpose national trust company regulated by the OCC. National Penn Bank’s other direct nonbank subsidiaries are subject to regulation by the OCC.

In addition, National Penn Capital Advisors, Inc., an investment advisory firm, and Vantage Investment Advisors, L.L.C., the investment advisory firm acquired in the Nittany acquisition (see “Recent Developments” herein), are each subject to regulation by the SEC, various state securities regulators and the NASD. National Penn Bank’s insurance agency subsidiaries are each also subject to regulation by the Pennsylvania Insurance Department.

Monetary and Fiscal Policies

The financial services industry, including National Penn and its subsidiaries, is affected by the monetary and fiscal policies of government agencies, including the Federal Reserve. Through open market securities transactions and changes in its discount rate and reserve requirements, the Federal Reserve exerts considerable influence over the cost and availability of funds for lending and investment.

Gramm-Leach-Bliley Act

The Gramm-Leach-Bliley Act of 1999 (“GLBA”):

• Repealed various provisions of the Glass Steagall Act to permit commercial banks to affiliate with investment banks (securities firms).

• Amended the BHCA to permit qualifying bank holding companies to engage in any type of financial activity.

• Permits subsidiaries of national banks now to engage in a broad range of financial activities that are not permitted for national banks themselves.

The result is that banking companies are generally able to offer a wider range of financial products and services and are more readily able to combine with other types of financial companies, such as securities and insurance companies.

GLBA created a new kind of bank holding company called a “financial holding company” (an “FHC”) that is authorized to engage in any activity that is “financial in nature or incidental to financial activities” and any activity that the Federal Reserve determines is “complementary to financial activities” and does not pose undue risks to the financial system. A bank holding company qualifies to become an FHC if it files an election with the Federal Reserve and if each of its depository institution subsidiaries is “well capitalized”, “well managed”, and CRA-rated “satisfactory” or better.  Although National Penn believes that it is eligible to do so, National Penn has not elected to become a “financial holding company.” National Penn has, instead, continued to utilize the continuing authority of national banks to create “operating subsidiaries” to expand its business products and services.

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GLBA also authorizes national banks to create “financial subsidiaries.” This is in addition to the present authority of national banks to create “operating subsidiaries.” A “financial subsidiary” is a direct subsidiary of a national bank that satisfies the same conditions as an FHC, plus certain other conditions, and is approved in advance by the OCC. A “financial subsidiary” can engage in most, but not all, of the newly authorized activities. National Penn Bank has not created any “financial subsidiaries.”

In addition, GLBA includes significant provisions relating to the privacy of consumer and customer information. These provisions apply to any company “the business of which” is engaging in activities permitted for an FHC, even if it is not itself an FHC. Thus, they apply to National Penn. GLBA requires a financial institution to adopt and disclose its privacy policy, give consumers and customers the right to “opt out” of disclosures to non-affiliated third parties, not disclose any account information to non-affiliated third party marketers and follow regulatory standards to protect the security and confidentiality of consumer and customer information.

Although the long-range effects of GLBA cannot be predicted, National Penn believes GLBA will further narrow the differences and intensify competition among commercial banks, investment banks, insurance firms and other financial services companies.

USA Patriot Act

In recent years, a major focus of governmental policy on financial institutions has been combating money laundering and terrorist financing. The USA Patriot Act of 2001 (the “Patriot Act”) gave the federal government new powers to address terrorist threats through enhanced domestic security measures, expanded surveillance powers and increased information sharing. It also substantially broadened the scope of federal anti-money laundering laws and regulations by imposing significant new compliance and due diligence policies, creating new crimes and penalties and expanding the extra-territorial jurisdiction of the United States. The United States Treasury Department has issued a number of regulations to implement various provisions of the Patriot Act. These regulations impose obligations on National Penn to maintain appropriate policies, procedures and controls to detect, prevent and report money laundering and terrorist financing and to verify the identity of its customers. Failure to maintain and implement adequate programs to combat money laundering and terrorist financing or to comply with all of the relevant laws or regulations could have an adverse impact on National Penn’s business.

Interest Rate Swaps

National Penn has used interest rate swap agreements for interest rate risk management. No derivative financial instruments are held for trading purposes. The contract or notional amounts of the swap agreements do not represent exposure to credit loss. Potential credit risk on these contracts arises from the counterparty’s inability to meet the terms of the agreement. Management considers the credit risk of these agreements to be minimal and manages this risk through routine review of the counterparty’s financial ratings.

Information about the amounts of interest rate swaps is set forth in Footnotes 1 and 16 of the Notes to Consolidated Financial Statements included at Item 8 of this Report. The Company had no interest rate swap agreements in 2005.

Critical Accounting Policies, Judgments and Estimates

The accounting and reporting policies of National Penn conform with accounting principles generally accepted in the United States of America and general practices within the financial services industry. Critical accounting policies, judgments and estimates relate to loans, the allowance for loan losses and goodwill and intangibles. These policies significantly affect the determination of National Penn’s financial position, results of operations and cash flows, and are summarized in Footnote 1 (Summary of Significant Accounting Policies) of the Notes to Consolidated Financial Statements and discussed in the section captioned “Critical Accounting Policies, Judgments and Estimates” of Management’s Discussion and Analysis of Financial Condition and Results of Operations, included in Items 7 and 8 of this Report, each of which is incorporated herein by reference.

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Recent Accounting Pronouncements

Share-Based Compensation

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 SFAS123R for public companies by issuing Release 33-8568. The new rule allows registrants to implement SFAS123R at the beginning of their next fiscal year, instead of the next interim period, that began after June 15, 2005. SFAS123R will therefore be effective for the Company beginning the first quarter of 2006. For the transition to SFAS123R, the Company anticipates utilizing the modified retrospective application to periods before the required effective date. Under this method of adoption, the Company will adjust its prior financial statements consistent with the amounts shown using the fair-value based method of accounting included in the pro forma disclosures in the footnotes to the consolidated financial statements. The Company also anticipates that it will continue utilizing the Black-Scholes option pricing model for valuing future stock option grants and anticipates annual future impact on the Company to be similar to the amounts disclosed in Footnote 1 to the Consolidated Finacial Statements at Item 8 of this Report.

Variable Interest Entities

In December 2003, the FASB issued a revised interpretation, FIN 46(R), 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 by $2.71 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 allows 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.

Acquired Loans

In October 2003, the AICPA issued SOP 03-3 Accounting for Loans or Certain Debt Securities Acquired in a Transfer. SOP 03-3 applies to a loan with the evidence of deterioration of credit quality since origination acquired by completion of a transfer for which it is probable at acquisition, that the Company will be unable to collect all contractually required payments receivable. SOP 03-3 requires that the Company recognize the excess of all cash flows expected at acquisition over the investor’s initial investment in the loan as interest income on a level-yield basis over the life of the loan as the accretable yield. The loan’s contractual required payments receivable in excess of the amount of its cash flows expected at acquisition (nonaccretable difference) should not be recognized as an adjustment to yield, a loss accrual or a valuation allowance for credit risk. SOP 03-3 is effective for loans acquired in fiscal years beginning after December 31, 2004. The Company adopted the provisions of SOP 03-3 effective January 1, 2005. The Statement did not have a material impact on the financial position or results of operations of the Company in 2005.

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Impairment of Investment Securities. In November 2005, the FASB issued FSP SFAS 115-1 and 124-1, “The Meaning of Other-Than-Temporary Impairment and Its Application to Certain Investments.” This FSP nullifies certain requirements of EITF 03-1 on this topic and provides additional guidance on when an investment in a debt or equity security should be considered impaired and when that impairment should be considered other-than-temporary and recognized as a loss in earnings. Specifically, the guidance clarifies that an investor should recognize an impairment loss no later than when the impairment is deemed other-than-temporary, even if a decision to sell has not been made. The FSP also required certain disclosures about unrealized losses that have not been recognized as other-than-temporary impairments. The amount of any other-than-temporary impairment that needs to be recognized will continue to be dependent on market conditions, the occurrence of certain events or changes in circumstances relative to an investee and an entity’s intent and ability to hold the impaired investment at the time of the valuation. FSP SFAS 115-1 and 124-1 was effective for reporting periods beginning after December 15, 2005. Adoption of this FSP did not have a material impact on the Company’s financial position or results of operations in 2005.

Accounting Changes and Error Corrections. In May 2005, the FASB issued SFAS 154, “Accounting Changes and Error Corrections.” This statement changes the accounting for and reporting of a chance in accounting principle. The statement applies to all voluntary changes in accounting principle and changes required by an accounting pronouncement in the unusual instance that the pronouncement does not include specific transition provisions. This statement requires retrospective application to prior period financial statements of changes in accounting principle, unless it is impractical to determine either the period-specific or cumulative effects of the change. SFAS 154 is effective for accounting changes made in fiscal years beginning after December 15, 2005. The adoption of this standard is not expected to have a material impact on the Company’s financial position or results of the operations.

Exchanges of Non-Monetary Assets. In December 2004, the FASB issued SFAS 153, “Exchanges of Nonmonetary Assets”, an amendment of APB Opinion 29, “Accounting for Nonmonetary Transactions.” This statement amends the principle that exchanges of nonmonetary assets should be measured based on the fair value of the assets exchanged and more broadly provides for exceptions regarding exchanges of nonmonetary assets that do not have commercial substance. This Statement is effective for nonmonetary asset exchanges occurring in fiscal periods beginning after June 15, 2005. The adoption of this standard is not expected to have a material impact on the Company’s financial position or results of operations.

Rental Costs. In October 2005, the FASB issued FSP SFAS 13-1, “Accounting for Rental Costs Incurred during a Construction Period.” The FAS concludes in this FSP that rental costs associated with ground or building operating leases that are incurred during a construction period should be expensed. FSP SFAS 13-1 was effective for reporting periods beginning after December 15, 2005. The adoption of this pronouncement did not have a material impact on the Company’s financial position or results of the operations.

Equity Investments. In July 2005, The FASB issued FSP APB 18-1, “Accounting by an Investor for Its Proportionate Share of Accumulated Other Comprehensive Income of an Investee Accounted for under the Equity Method in Accordance with APB Opinion No. 18 upon a Loss of Significant Influence.” This FSP provides that an investor’s proportionate share of an investee’s equity adjustments for “other comprehensive income” should be offset against the carrying value of the investment at the time significant influence is lost. At that time, an investor would reduce its investment account, to no less than zero, with any balance remaining reflected in income. The guidance in this FSP was effective in the first reporting period beginning after July 12, 2005. The adoption of this pronouncement did not have a material impact on the Company’s financial position or results of the operations.

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Statistical Disclosures - Management’s Discussion and Analysis

The following statistical disclosures are included in Item 7 of this Report, Management’s Discussion and Analysis of Financial Condition and Results of Operations, and are incorporated by reference in this Item 1:

• Interest Rate Sensitivity Analysis.

• Interest Income and Expense, Volume and Rate Analysis.

• Average Balances, Average Rates, and Interest Rate Spread.

• Investment Portfolio.

• Loan Maturity and Interest Rate Sensitivity.

• Loan Portfolio.

• Risk Elements - Loans.

• Allowance for Loan Losses.

• Deposits.

• Short-Term Borrowings.

• Return on Equity and Assets; Dividend Payout Ratio.

Item 1A. RISK FACTORS.

National Penn’s business is subject to interest rate risk and variations in interest rates may negatively affect its financial performance.

Changes in the interest rate environment may reduce profits. The primary source of income for National Penn is the differential or “spread” between the interest earned on loans, securities and other interest-earning assets, and interest paid on deposits, borrowings and other interest-bearing liabilities. As prevailing interest rates change, net interest spreads are affected by the difference between the maturities and repricing characteristics of interest-earning assets and interest-bearing liabilities. In addition, loan volume and yields are affected by market interest rates on loans, and rising interest rates generally are associated with a lower volume of loan originations. An increase in the general level of interest rates may also adversely affect the ability of certain borrowers to pay the interest on and principal of their obligations. Accordingly, changes in levels of market interest rates could materially adversely affect National Penn’s net interest spread, asset quality, loan origination volume and overall profitability.

Future governmental regulation and legislation could limit National Penn’s future growth.

National Penn and its subsidiaries are subject to extensive state and federal regulation, supervision and legislation that govern almost all aspects of the operations of National Penn and its subsidiaries. These laws may change from time to time and are primarily intended for the protection of consumers, depositors and the governments deposit insurance funds. Any changes to these laws may negatively affect National Penn’s ability to expand its services and to increase the value of its business. While we cannot predict what effect any presently contemplated or future changes in the laws or regulations or their interpretations would have on National Penn, these changes could be materially adverse to National Penn’s shareholders.

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National Penn’s ability to pay dividends depends primarily on dividends from its national bank subsidiary, which are subject to regulatory limits.

National Penn is a bank holding company and its operations are conducted by direct and indirect subsidiaries, each of which is a separate and distinct legal entity. Substantially all of National Penn’s assets are held by its direct and indirect subsidiaries.

National Penn’s ability to pay dividends depends on its receipt of dividends from its direct and indirect subsidiaries. Its national bank subsidiary, National Penn Bank, including National Penn Bank’s divisions, the FirstService Bank, HomeTowne Heritage Bank and The Peoples Bank of Oxford Divisions, is National Penn’s primary source of dividends. Dividend payments from National Penn Bank are subject to legal and regulatory limitations, generally based on net profits and retained earnings, imposed by bank regulatory agencies. The ability of National Penn Bank to pay dividends is also subject to its profitability, financial condition, capital expenditures and other cash flow requirements. At December 31, 2005, approximately $54,498,000 was available without the need for regulatory approval for the payment of dividends to National Penn from National Penn Bank. There is no assurance that National Penn Bank and/or National Penn’s other subsidiaries will be able to pay dividends in the future or that National Penn will generate adequate cash flow to pay dividends in the future. National Penn’s failure to pay dividends on its common stock could have a material adverse effect on the market price of its common stock.

National Penn’s future acquisitions could dilute ownership of National Penn and may cause National Penn to become more susceptible to adverse economic events.

National Penn has used its common stock to acquire other companies in the past and intends to acquire or make investments in banks and other complementary businesses with its common stock in the future. National Penn may issue additional shares of common stock to pay for those acquisitions, which would dilute the ownership interest of present shareholders in National Penn. Future business acquisitions could be material to National Penn, and any failure to integrate these businesses into National Penn could have a material adverse effect on the value of National Penn common stock. In addition, any such acquisition could require National Penn to use substantial cash or other liquid assets or to incur debt. In those events, National Penn could become more susceptible to economic downturns and competitive pressures.

Competition from other financial institutions may adversely affect National Penn’s profitability.

National Penn’s subsidiaries face substantial competition in originating loans, both commercial and consumer. This competition comes principally from other banks, savings institutions, mortgage banking companies and other lenders. Many of National Penn’s competitors enjoy advantages, including greater financial resources and higher lending limits, a wider geographic presence, more accessible branch office locations, the ability to offer a

wider array of services or more favorable pricing alternatives, as well as lower origination and operating costs. This competition could reduce National Penn’s net income by decreasing the number and size of loans that National Penn’s subsidiaries originate and the interest rates they may charge on these loans.

In attracting business and consumer deposits, National Penn’s subsidiaries face substantial competition from other insured depository institutions such as banks, savings institutions and credit unions, as well as institutions offering uninsured investment alternatives, including money market funds. Many of National Penn’s competitors enjoy advantages, including greater financial resources, more aggressive marketing campaigns and better brand recognition and more branch locations. These competitors may offer higher interest rates than National Penn, which could decrease the deposits that National Penn attracts or require National Penn to increase its rates to retain existing deposits or attract new deposits. Increased deposit competition could adversely affect National Penn’s ability to generate the funds necessary for lending operations. As a result, National Penn may need to seek other sources of funds that may be more expensive to obtain and could increase National Penn’s cost of funds. 

National Penn’s banking and non-banking subsidiaries also compete with non-bank providers of financial services, such as brokerage firms, consumer finance companies, credit unions, insurance agencies and governmental organizations which may offer more favorable terms. Some of National Penn’s non-bank competitors are not subject to the same extensive regulations that govern its banking operations. As a result, such non-bank competitors may have advantages over National Penn’s banking and non-banking subsidiaries in providing certain products and services. This competition may reduce or limit National Penn’s margins on banking and non-banking services, reduce its market share and adversely affect its earnings and financial condition.

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A Warning About Forward-Looking Information

This Annual Report, including information incorporated by reference in this Annual Report, contains forward-looking statements with respect to the financial condition, results of operations and business of National Penn and its subsidiaries. In addition, from time to time, National Penn or its representatives may make written or oral forward-looking statements. These statements can be identified by the use of forward-looking terminology such as "believe," "expect," "may," "will," "should,'' "project," "plan,'' "seek," "intend,'' or "anticipate'' or the negative thereof or comparable terminology, and include discussions of strategy, financial projections and estimates and their underlying assumptions, statements regarding plans, objectives, expectations or consequences of the transactions, and statements about the future performance, operations, products and services of the companies and its subsidiaries.

National Penn’s businesses and operations, including those acquired on January 26, 2006 in the acquisition of Nittany and its subsidiaries (see “Recent Developments” herein), are and will be subject to a variety of risks, uncertainties and other factors. Consequently, their actual results and experience may materially differ from those contained in any forward-looking statements. Such risks, uncertainties and other factors that could cause actual results and experience to differ from those projected include, but are not limited to, the following:

• Reputational risk created by the loan fraud incurred by National Penn in 2004 may have an adverse impact on business generation and retention, funding, liquidity and National Penn’s stock price.

• 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. Use of non-National Penn brands may be counter-productive.

• 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 mergers and acquisitions such as the Nittany acquisition, 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.

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• Projected business increases following new product development, geographic expansion, 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, including mortgage origination levels.

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

• General economic or business conditions, either nationally or in the regions in which National Penn will be doing business, may be less favorable than expected, resulting in, among other things, a deterioration in credit quality or a reduced demand for credit.

• Expected synergies and cost savings from mergers and acquisitions, including the Nittany acquisition, may not be fully realized or realized as quickly as expected.

• Revenues and loan growth following mergers and acquisitions, including the Nittany acquisition, may be lower than expected.

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

• Business opportunities and strategies potentially available to National Penn after mergers and acquisitions, including the Nittany acquisition, 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 and its subsidiaries, with National Penn’s business or systems 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.

• Legislation or regulatory changes, including without limitation, changes in laws or regulations on competition, industry consolidation, development of competing financial products and services, changes in accounting rules and practices, changes in or additional 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.

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• 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 1B. UNRESOLVED STAFF COMMENTS.

None.

Item 2. PROPERTIES.

National Penn does not own or lease any property. As of December 31, 2005, National Penn Bank owns 48 properties in fee and leases 62 other properties; and National Penn’s other direct and indirect subsidiaries lease five properties. The properties owned in fee are not subject to any major liens, encumbrances, or collateral assignments.

The principal office of National Penn and National Penn Bank is owned in fee and located at Philadelphia and Reading Avenues, Boyertown, Pennsylvania 19512.

National Penn Bank presently has 73 community offices located in the following Pennsylvania counties: Berks, Bucks, Chester, Delaware, Lancaster, Lehigh, Montgomery, Northampton, and Philadelphia, as well as one in Cecil County, Maryland. In addition to these offices, National Penn Bank presently owns or leases 75 automated teller machines located throughout these ten counties, all of which are located at community office locations except for 11 that are “free-standing” (not located at an office).

Nittany Bank owns three properties in fee and leases five other properties. They also own three “free-standing” automated teller machines.

Due to its growth, the Company is experiencing a space shortage and is planning for the possible construction of an operations facility. In 2005, the Company acquired a tract of land in Amity Township, Berks County, Pennsylvania, for this purpose. The land use township approval process for an operations center of up to 70,000 square feet is currently pending. The actual construction and timing of such construction is unknown and various interim space planning is ongoing.

Item 3. LEGAL PROCEEDINGS.

As previously disclosed by National Penn in its Annual Report on Form 10-K for 2004, 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. 2005 financial results included pre-tax expenses of $1.9 million for legal, auditing and other investigation-related expenses in the investigation of the loan fraud. National Penn anticipates that it will continue to incur legal and other investigation-related expenses in future periods.

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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. In first quarter 2006, National Penn received approximately $398,000 in partial settlement of an insurance claim filed with respect to the loan fraud. National Penn continues to pursue all available avenues, including insurance, to recover its remaining losses, and to cooperate with law enforcement authorities in their investigation.

Item 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS.

No matters were submitted to a vote of the National Penn shareholders during the fourth calendar quarter of 2005.

Item 4A. EXECUTIVE OFFICERS OF THE REGISTRANT.

The principal executive officers of National Penn, as of March 1, 2006, are as follows:

Name	Age	Principal Business Occupation During the Past Five Years
Wayne R. Weidner	63	Chairman and Chief Executive Officer of National Penn. Chairman, President and Chief Executive Officer of National Penn from January 2002 until December 2003. President and Chief Executive Officer of National Penn in 2001, and President from 1998 to 2000. Also, Chairman of National Penn Bank.
Glenn E. Moyer	54	President of National Penn and President and Chief Executive Officer of National Penn Bank since December 2003. Executive Vice President of National Penn from April 2001 to December 2003 and President and Chief Operating Officer of National Penn Bank from January 2001 to December 2003. Executive Vice President and Chief Lending Officer of National Penn Bank and President of National Penn Bank’s Elverson National Bank Division from January 1999 to January 2001.
Bruce G. Kilroy	56	Group Executive Vice President of National Penn since January 2001. President of National Penn Bank’s Lehigh Valley Division from February 1997 to December 2004.
Garry D. Koch	51	Group Executive Vice President and Director of Risk Management of National Penn since January 2001. Executive Vice President of National Penn Bank from September 1997 to January 2001.

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Paul W. McGloin	58	Group Executive Vice President and Chief Lending Officer of National Penn since January 2002. Executive Vice President of National Penn Bank from March 2001 to January 2002. President of National Penn Bank’s Main Line/Chestnut Hill/Philadelphia Division since March 2001. Prior thereto, Managing Director, Capital Markets, of First Union National Bank.
Sharon L. Weaver	58	Group Executive Vice President of National Penn since January 2001. Executive Vice President of National Penn Bank from April 1998 to January 2001.
Sandra L. Spayd	62	Group Executive Vice President, Secretary and Corporate Governance Officer of National Penn. Corporate Secretary of National Penn Bank. Executive Vice President and Corporate Secretary of National Penn Bank from January 2002 to January 2004. Senior Vice President and Corporate Secretary of National Penn Bank prior to January 2002.
Gary L. Rhoads	51	Group Executive Vice President, Treasurer and Chief Financial Officer of National Penn. Chief Financial Officer of National Penn Bank. Executive Vice President, Controller and Cashier of National Penn Bank prior to January 2001.
Michael R. Reinhard	48	Group Executive Vice President and Corporate Planning Officer of National Penn since January 2004. Executive Vice President of National Penn Bank from January 2002 to January 2004. Senior Vice President of National Penn Bank prior to January 2002.
Michelle H. Debkowski	37	Senior Vice President and Chief Accounting and Investor Relations Officer of National Penn since October 2004. Senior Vice President of National Penn Bank since January 2003. Regulatory Compliance Director of National Penn and National Penn Bank from August 1995 to October 2004.
H. Anderson Ellsworth	58	Senior Vice President and Securities Law Compliance Director of National Penn since October 2004. Prior thereto, President and Shareholder of Ellsworth, Carlton, Mixell & Waldman, P.C. (law firm).

The Chief Executive Officer and the President of National Penn are elected by National Penn’s Board of Directors and serve until they resign, retire, become disqualified, or are removed by the Board. Other National Penn executive officers are approved by the Compensation Committee of the Board and serve until they resign, retire, become disqualified, or are removed by the Committee.

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PART II

Item 5. MARKET FOR THE REGISTRANT’S COMMON EQUITY, RELATED STOCKHOLDER MATTERS AND ISSUER PURCHASES OF EQUITY SECURITIES.

National Penn’s common stock currently trades on the NASDAQ National Market tier of The NASDAQ Stock Market under the symbol: “NPBC”. As of March 3, 2006, National Penn had 46,683,321 shareholders of record.

The following table reflects the high and low closing sale prices reported for National Penn’s common stock, and the cash dividends declared on National Penn’s common stock, for the periods indicated, after giving retroactive effect to a five-for-four stock split at September 30, 2005.

 

MARKET VALUE OF COMMON STOCK

	2005
	High		Low
1st Quarter	$	21.99	$	19.16
2nd Quarter		20.50		17.94
3rd Quarter		22.13		19.26
4th Quarter		21.00		18.14
	2004
	High		Low
1st Quarter	$	21.94	$	19.31
2nd Quarter		20.78		17.85
3rd Quarter		20.66		17.54
4th Quarter		23.70		20.08

 

CASH DIVIDENDS DECLARED ON COMMON STOCK

		2005		2004
1st Quarter	$	0.1600	$	0.1536
2nd Quarter		0.1600		0.1536
3rd Quarter		0.1600		0.1536
4th Quarter		0.1650		0.1600

National Penn’s ability to pay cash dividends to its shareholders is substantially dependent upon the ability of its national bank subsidiary, National Penn Bank, to pay cash dividends to National Penn. Information on regulatory restrictions upon National Penn Bank’s ability to pay cash dividends is set forth in Footnote No. 18 to the Consolidated Financial Statements included in Item 8 of this Report, which information is incorporated by reference in this Item 5.

The Trust Preferred Securities of NPB Capital Trust II are reported on NASDAQ’s National Market under the symbol “NPBCO”. These securities have a par value of $25.00 and the preferred dividend is 7.85%.

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The following table provides information on repurchases by National Penn of its common stock in each month of the quarter ended December 31, 2005.

			Total Number of	Maximum Number
			Shares Purchased as	of Shares that may
			Part of Publicly	yet be Purchased
	Total Number of	Average Price Paid	Announced Plans	Under the Plans
Period	Shares Purchased	Per Share	or Programs	or Programs
October 1, 2005
Through
October 31, 2005	11,700	$16.67	11,700	574,017
November 1, 2005
Through
November 30, 2005	189,500	$19.95	189,500	384,517
December 1, 2005
Through
December 31, 2005	115,974	$20.58	115,974	2,268,543

1.	Transactions are reported as of settlement dates.
2.	National Penn's current stock repurchase programs were approved by its Board of Directors and
	announced on September 24, 2003 and December 22, 2005. National Penn intends to complete
	all stock repurchases authorized under the September 2003 program before beginning any stock
	repurchases authorized under the December 2005 program.
3.	The number of shares approved for repurchase under National Penn's current stock repurchase
	programs is 1,562,500 (as adjusted for the five-for-four stock split on September 30, 2005) and
	2,000,000, respectively.
4.	Neither of National Penn's current stock repurchase programs has 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.
7.	The maximum number of shares that may yet be purchased includes the reduction for National
	Penn shares indirectly acquired on June 10, 2004 upon the closing of the Peoples First, Inc.
	acquisition, reflecting National Penn’s pre-existing ownership of Peoples First stock.
8.	The maximum number of shares that may yet be purchased as of December 31, 2005 includes the
	2,000,000 shares approved for repurchase under the 2005 stock repurchase program.

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Item 6. SELECTED FINANCIAL DATA
Five-Year Statistical Summary
(dollars in thousands, except per share data)
Year Ended	2005			2004			2003			2002			2001
BALANCE SHEET (1)
Total assets	$	4,600,609		$	4,478,793		$	3,512,574		$	2,858,262		$	2,727,482
Total deposits		3,309,046			3,143,193			2,435,296			1,925,964			1,931,350
Loans and Leases, net (2)		2,993,744			2,816,849			2,221,434			1,744,829			1,736,370
Total investment securities		1,091,714			1,189,803			934,375			650,930			597,687
Total shareholders’ equity		444,888			428,125			317,813			222,360			195,682
Book value per share (3)		10.26			9.93			8.38			6.55			5.70
Percent shareholders’ equity to assets		9.67	%		9.56	%		9.05	%		7.78	%		7.17	%
Trust and other assets under management		1,651,322			1,284,264			1,038,756			778,246			843,755
EARNINGS (1), (4)
Total interest income	$	242,586		$	198,775		$	165,648		$	163,178		$	180,748
Total interest expense		93,937			60,493			51,099			61,098			90,330
Net interest income		148,649			138,282			114,549			102,080			90,418
Provision for loan and lease losses		3,200			4,800			9,371			13,585			8,450
Net interest income after provision for
Loan and lease losses		145,449			133,482			105,178			88,495			81,968
Other income		57,016			46,774			41,285			36,550			32,186
Other expenses		123,103			117,491			103,033			82,268			74,433
Income before income taxes		79,362			62,765			43,430			42,777			39,721
Income taxes		19,607			14,851			8,697			8,603			7,756
Net income from continuing operations		59,755			47,914			34,733			34,174			31,965
Net income from discontinued operations		-			-			8,621			2,060			769
Net income	$	59,755		$	47,914		$	43,354		$	36,234		$	32,734
Cash dividends paid	$	27,973		$	25,199		$	21,234		$	17,664		$	16,519
Dividend payout ratio		46.81	%		52.59	%		48.98	%		48.75	%		50.46	%
Return on average assets		1.31	%		1.20	%		1.34	%		1.30	%		1.25	%
Return on average shareholders’ equity		13.7	%		13.2	%		16.2	%		17.4	%		16.8	%
PER SHARE DATA (3)
Basic earnings	$	1.38		$	1.17		$	1.17		$	1.06		$	0.95
Diluted earnings		1.36			1.15			1.14			1.05			0.94
Dividends paid in cash		0.645			0.621			0.574			0.517			0.479
Dividends paid in stock		5-for-4			5-for-4			5	%		5	%		3	%
		stock split			stock split
SHAREHOLDERS AND STAFF
Average shares outstanding-basic *		43,328,813			40,797,270			37,207,715			34,088,596			34,427,536
Average shares outstanding-diluted *		44,048,486			41,689,071			38,142,224			34,535,890			34,837,228
Shareholders of record		4,374			4,316			3,684			3,346			3,338
Staff - Full-time equivalents		1,141			1,098			940			840			783

(1) Balances have been adjusted for the sale in 2003 of Panasia Bank. N.A. which is being presented as discontinued operations.

(2) Includes loans held for sale.

(3) Adjusted to reflect five-for-four stock splits in 2005 and 2004, a 5% stock dividend in 2003 and 2002, and a 3% stock dividend in 2001.

(4) Results of operations are included for the Peoples First, Inc. acquisition for the period July 1, 2004 through December 31, 2004, HomeTowne Heritage Bank for the period December 12, 2003 through December 31, 2003 and the FirstService Bank for the period February 25, 2003 through December 31, 2003.

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Item 7. 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. The following discussion and analysis should be read in conjunction with the Company’s consolidated financial statements. 

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 achieving 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 is a strategic initiative by the Company in furtherance of its focused goals. The acquisitions of FirstService Bank and HomeTowne Heritage Bank in 2003 were similar strategic initiatives. The acquisition of Nittany Financial Corp. and its subsidiary, Nittany Bank, in first quarter 2006 is also a similar strategic initiative.

The current economic climate and interest rate environment present challenges for all financial institutions in achieving their business goals. Continued interest margin compression makes asset growth a priority, as well as the development of fee income. The Company’s goal is for asset growth each year to be generated through a combination of internal growth and growth by mergers and acquisitions. In 2005, substantially all asset growth was internally generated. In 2004, approximately one-half of the Company’s asset growth was internally generated, and the other half was attributable to the Peoples First, Inc. acquisition. In the fee income area, the Company’s goal is to develop its wealth management and insurance businesses more fully throughout the Company’s entire geographic footprint.

In addition to historical information, this Form 10-K contains forward-looking statements. 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 in this Report at Item 1A. Risk Factors, which information is incorporated by reference into this Management’s Discussion and Analysis.

In September 2003, the Company completed the cash sale of its subsidiary, Panasia Bank, N.A. (“Panasia”). All financial information in this Management’s Discussion and Analysis for 2003, 2002, and 2001 is restated to exclude Panasia. The sale of Panasia is presented as discontinued operations under SFAS No. 144. This presentation is intended to aid comparison of current and prior year results with future results.

All actual share and per share information is restated to reflect a five-for-four stock split of the Company’s common stock effective September 30, 2005, a five-for-four stock split of the Company’s common stock effective September 30, 2004, and a 5% stock dividend paid on the Company’s common stock on September 30, 2003.

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 banking industry. The preparation of financial statements in conformity with accounting principles generally accepted in the United States of America requires management to make estimates and the 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 or collateral liquidation values 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 portfolio. All of these factors may be susceptible to significant change. To the extent actual outcomes differ from management estimates, additional provisions for loan 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 a 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. Through its annual analysis as of June 30, 2005, the Company has not identified any impairment of its goodwill. No events occurred during third or fourth quarter 2005 necessitating a re-test of goodwill impairment. 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 carry-forwards 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 substantially 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 previous years.

FINANCIAL CONDITION

At December 31, 2005, total assets were $4.60 billion, an increase of $ 121.8 million or 2.72% from the $4.48 billion at December 31, 2004. The increase in assets in 2005 is reflected primarily in the loan and lease category, the cash and due from banks category and the other assets category, which increased $175.4 million, $31.4 million and $11.0 million, respectively. These increases were offset by a $98.1 million decrease in investments over the prior year.

Total assets at the end of 2004 increased $966.0 million or 27.5% to $4.48 billion over the $3.51 billion at year-end 2003. The increase in assets in 2004 is reflected primarily in the loan and lease category, the investment category and the goodwill and other intangibles category, which increased $595.4 million, $255.4 million and $94.2 million, respectively. The increase in assets as of December 31, 2004 is primarily due to the acquisition of Peoples First on June 10, 2004, which had $455.9 million in assets at time of acquisition.

LOAN PORTFOLIO

Net loans and leases, including loans held for sale, increased to $2.99 billion during 2005, an increase of $176.9 million or 6.3% compared to 2004. Net loans increased $595.4 million in 2004 or 26.8% compared to 2003. The Company gained $361.6 million in net loans in 2004 due to the addition of Peoples First, Inc. on June 10, 2004. Excluding the Peoples First acquisition, core loan growth was 10.5% in 2004. Loans continue to increase at a modest pace as a result of the slowly improving economy and the modestly improved level of capital goods spending by the Company’s business customers. Residential mortgages originated for immediate resale during the year ended December 31, 2005 amounted to $339.4 million. The Company had $18.6 million in loans held for sale at December 31, 2005.

32

Net loans and leases, including loans held for sale, increased to $2.82 billion in 2004, an increase of $595.4 million or 26.8% compared to December 31, 2003.

The Company’s loans are widely diversified by borrower, industry group, and geographical area in southeastern Pennsylvania. The following summary shows the year-end composition of the Company’s loan portfolio (in thousands) (1):

	2005		2004		2003		2002		2001
Commercial and Industrial Loans and Leases	$	708,653	$	625,554	$	482,884	$	355,977	$	343,001
Real Estate Loans:
Construction and Land Dev.		206,201		201,410		149,531		122,129		128,655
Residential		1,078,772		1,025,955		754,977		677,559		650,135
Other (nonfarm, nonresidential)		995,596		957,677		828,843		574,443		575,747
Loans to Individuals		60,586		63,843		54,466		55,299		79,280
Total	$	3,049,808	$	2,874,439	$	2,270,701	$	1,785,407	$	1,776,819

(1) The classification of loans in the above table corresponds to defined bank regulatory reporting categories and is presented for analytical purposes. Internal classification of loans is described in Item 1., “Lending”, of this Report.

Maturities and sensitivity to changes in interest rates in certain loan categories in the Company’s loan portfolio at December 31, 2005, are summarized below (in thousands):

	One year or Less*	After One Year to Five Years	After Five Years	Total
Commercial and Industrial Loans and Leases	$416,101	$182,305	$110,247	$708,653
Construction and Land Dev.	130,692	48,789	26,719	206,201
	$546,793	$231,094	$136,966	$914,854

*Demand loans, past-due loan and overdrafts are reported in “One Year or Less.” An immaterial amount of loans have no stated schedule of repayments.

Loan balances segregated in terms of sensitivity to changes in interest rates at December 31, 2005, are summarized below (in thousands):

	After One Year to Five Years		After Five Years
Predetermined Interest Rate	$	192,122	$	110,248
Floating Interest Rate		38,971		26,719
Total	$	231,094	$	136,967

Determinations of maturities included in the loan maturity table are based upon contract terms. In situations where a renewal is appropriate, the Company’s policy in this regard is to evaluate the credit for collectibility consistent with the normal loan evaluation process. This policy is used primarily in evaluating ongoing customers’ use of their lines of credit that are at floating interest rates. As of December 31, 2005, the Company’s outstanding lines of credit to customers total $412.1 million.

33

RISK ELEMENTS - LOANS

A loan is placed in a nonaccrual status at the time when ultimate collectibility of principal or interest, wholly or partially, is in doubt. Past due loans are those loans which were contractually past due 90 days or more as to interest or principal payments but are well secured and in the process of collection. Restructured loans are those loans which terms have been renegotiated to provide a reduction or deferral of principal or interest as a result of the deteriorating financial position of the borrower.

Nonperforming Assets

(in thousands)	December 31,
	2005		2004			2003			2002		2001
Nonaccrual Loans	$	11,961	$	11,103		$	13,673		$	14,046	$	14,234
Loans Past Due 90 or More Days as to Interest or Principal		183		870			318			928		11,582
Total Nonperforming Loans		12,144		11,973			13,991			14,974		25,816
Other Real Estate Owned		-		-			735			318		1,013
Total Nonperforming Assets	$	12,144	$	_11,973		$	14,726		$	15,292	$	26,829
Gross Amount of Interest that Would Have Been Recorded at Original Rate on Nonaccrual and Restructured Loans	$	878	$	492		$	449		$	709	$	1,547
Interest Received From Customers on Nonaccrual and Restructured Loans		441		835			613			463		424
Net Impact on Interest Income of Nonperforming Loans	$	437	$	(343	)	$	(164	)	$	246	$	1,123

Nonperforming assets, including nonaccruals, loans 90 days past due, restructured loans and other real estate owned, were $12.1 million at December 31, 2005, compared to $12.0 million at December 31, 2004. Nonaccrual loans represented $12.0 million and $11.1 million at December 31, 2005, and December 31, 2004, respectively. Loans 90 days past due and still accruing interest were $183,000 and $870,000 at December 31, 2005 and December 31, 2004, respectively. Additional discussion regarding this issue is set forth in the paragraph of this Item 7 titled “Allowance for Loan and Lease Losses”.

The Company had no assets classified as other real estate owned at December 31, 2005 and December 31, 2004. The Company had no restructured loans at December 31, 2005 or December 31, 2004.

The allowance for loan and lease losses to nonperforming assets was 462% and 481% at December 31, 2005 and December 31, 2004, respectively, with the decrease in 2005 due to the decreased level of total allowance for loan and lease losses. Another measure of the Company’s credit quality is reflected by the ratio of net chargeoffs to total loans and leases of 0.15% for 2005 versus 0.10% for the year 2004, and the ratio of nonperforming assets to total loans of .40% at December 31, 2005, compared to .42% at December 31, 2004. Of the $4.7 million in net chargeoffs in 2005, $2.6 million were commercial and industrial loans.

The Company has not engaged in any transactions with entities established and operated by former members of senior management or individuals with former management relationships with the Company.

34

INVESTMENT PORTFOLIO

The investment portfolio is primarily a secondary source of liquidity, but it also serves as a source of income. As such, the investment portfolio consists of shorter-term investments that provide current liquidity and longer-term investments that provide higher income. Over the past three years, the Company has worked to shorten the duration of the investment portfolio in response to lower interest rates and to help improve liquidity. Regardless of classification as to shorter-term or longer-term, the majority of the Company’s investments are readily marketable securities held as available for sale, and the majority of the Company’s investments qualify as collateral for deposit pledging needs.

Certain investment securities purchased during the second half of 2004 were classified as held to maturity. Due to our pledging requirements, these securities would most likely be held to maturity regardless of classification.

Investments of both held to maturity and available for sale securities decreased $98.1 million or 8.2% to

$1.09 billion at December 31, 2005 compared to December 31, 2004. Investment purchases during 2005 were

$243.9 million, primarily U.S. Government Agency and municipal securities. This increase was partially offset by

investment calls and maturities and the amortization of mortgage backed securities totaling $272.3 million. Also,

during 2005, the Company sold approximately $46.3 million in investment securities available for sale resulting in $555,000 in net gains. The sale proceeds were re-deployed into higher-yielding investments.

A summary of investment securities available for sale at December 31, 2005, 2004 and 2003 follows (in thousands):

	2005				2004				2003
	Amortized Cost		Fair Value		Amortized Cost		Fair Value		Amortized Cost		Fair Value
US Treasuries and Agencies	$	178,412	$	175,650	$	219,285	$	220,744	$	111,183	$	114,792
State and Municipal		232,738		243,289		261,906		279,565		259,623		277,807
Mortgage-backed securities		468,758		458,460		529,033		530,221		480,803		484,746
Marketable equity secs. & other		56,298		63,707		57,974		68,306		53,781		57,030
Total	$	936,206	$	941,106	$	1,068,198	$	1,098,836	$	905,390	$	934,375

A summary of investment securities held to maturity at December 31, 2005, 2004 and 2003 follows (in thousands):

	2005				2004				2003
	Amortized Cost		Fair Value		Amortized Cost		Fair Value		Amortized Cost		Fair Value
State and municipal	$	71,396	$	70,820	$	-	$	-	$	-	$	-
Mortgage-backed securities		79,212		76,808		90,967		90,621		-		-
Total	$	150,608	$	147,628	$	90,967	$	90,621	$	-	$	-

35

The maturity distribution and weighted average yield of the investment securities of the Company at December 31, 2005 are presented in the following tables. Weighted average yields on tax-exempt obligations have been computed on a fully taxable equivalent basis assuming a tax rate of 35%. All average yields were calculated on the book value of the related securities. Stocks and other securities having no stated maturity have been included in the “After 10 Years” category.

Securities Available for Sale - Yield by Maturity

(Dollars in thousands)

	Within 1 Year					After 1 But Within 5 Yrs					After 5 But Within 10 Yrs					After 10 Yrs					Total
	Amt		Yld			Amt		Yld			Amt		Yld			Amt		Yld			Amt		Yld
US Treasuries and Agencies	$	16,158		5.25	%	$	156,598		4.16	%	$	2,894		4.79	%	$	-		-	%	$	175,650		4.26	%
State and Municipal		1,669		5.98	%		28,589		6.27	%		50,764		7.51	%		162,267		8.12	%		243,289		7.83	%
Mortgage-backed securities		20		5.58	%		135,800		3.76	%		107,790		3.89	%		214,850		5.12	%		458,460		4.43	%
Marketable equity secs.
& other		-		-	%		3,764		5.52	%		526		8.18	%		59,417		3.38	%		63,707		3.54	%
Total	$	17,847		5.32	%	$	324,751		4.19	%	$	161,974		5.05	%	$	436,534		6.00	%	$	941,106		5.22	%

Securities Held to Maturity at Market Value

(Dollars in thousands)

	Within 1 Year				After 1 But Within 5 Yrs				After 5 But Within 10 Yrs					After 10 Yrs					Total
	Amt		Yld		Amt		Yld		Amt		Yld			Amt		Yld			Amt		Yld
State and municipal	$	-		-	$	-		-	$	-		-	%	$	70,820		6.48	%	$	70,820		6.48	%
Mortgage-backed securities		-		-		-		-		76,808		3.96	%		-		-	%		76,808		3.96	%
Total	$	-		-	$	-		-	$	76,808		3.96	%	$	70,820		6.48	%	$	147,628		5.17	%

OTHER ASSETS

Other assets on the balance sheet increased to $392.7 million, an increase of $14.4 million compared to the $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. The other asset category accounted for $11.0 million of the increase. This increase in other assets was due to a deferred tax asset account associated with valuation of the investment portfolio.

As of December 31, 2004, other assets increased $119.8 million or 46.4% compared to December 31, 2003. Goodwill and other intangibles accounted for $100.8 million (net of amortization of intangibles) of the increase, resulting from the Peoples First, Inc., Pennsurance, Inc., and D. E. Love Associates, Inc. acquisitions in 2004. Premises and equipment increased $10.1 million due to the Peoples First, Inc. acquisition and bank owned life insurance increased $9.6 million due to the acquisitions and the increased cash surrender value of the insurance policies held by the Company.

36

DEPOSITS

As the primary source of funds, aggregate deposits of $3.31 billion at December 31, 2005 increased $165.9 million or 5.3% compared to 2004. The increase in 2005 is due to aggressively recapturing core deposits, through promotional deposit rates. In 2005, non-interest bearing deposits decreased $6.0 million and interest bearing deposits increased $171.8 million.

Deposits of $3.14 billion at December 31, 2004 increased $707.9 million or 29.1% compared to deposits at December 31, 2003. The increase in 2004 was primarily due to the addition of Peoples First, Inc. deposits of $381.2 million and other growth in deposits of $326.8 million. The deposit growth in 2004 consisted of $129.3 million in non-interest bearing deposits and $578.6 million in interest bearing deposits.

The following is a distribution of the average amount of, and the average rate paid on, the Company’s deposits for each year in the three-year period ended December 31, 2005 (dollars in thousands):

	2005					2004					2003
	Average Amount		Average Rate			Average Amount		Average Rate			Average Amount		Average Rate
Non-interest bearing demand deposits	$	511,620		--	%	$	460,759		--	%	$	344,911		--	%
Savings deposits		1,570,145		1.61	%		1,551,289		1.00	%		1,185,821		0.93	%
Time deposits		1,050,061		3.38	%		747,570		3.01	%		713,874		3.18	%
Total	$	3,131,826		1.94	%	$	2,759,618		1.38	%	$	2,244,606		1.63	%

The aggregate amount of jumbo certificates of deposits, issued in the amount of $100,000 or more was $480,975,000 in 2005, $246,948,000 in 2004, and $137,965,000 in 2003.

The following is a breakdown, by maturities, of the Company’s time certificates of deposit of $100,000 or more as of December 31, 2005. The Company has no other time deposits of $100,000 or more as of December 31, 2005 (dollars in thousands):

Maturity
3 months or less	$	107,149
Over 3 through 6 months		89,689
Over 6 months through 12 months		142,734
Over 12 months		141,403
Total	$	480,975

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 borrowings, and subordinated debentures. In the aggregate, these funds totaled $804.2 million at the end of 2005, a $66.8 million or 7.7% decrease compared to year-end 2004. Total securities sold under repurchase agreements declined $67.0 million, due to the repayment of FHLB repurchase agreements. Federal funds purchased also declined $18.0 million since December 31, 2004. Long-term borrowings increased $18.5 million as a result of paying down short-term borrowings to lock in lower long-term rates. Subordinated debt was classified as “guaranteed preferred beneficial interest in Company’s subordinated debentures” prior to the Company’s adoption of FIN-46(R) as of March 31, 2004. See Footnote 8 to the Consolidated Financial Statements included in this Report at Item 8.

37

Total borrowings and purchased funds of $871.0 million at December 31, 2004 exceeded total borrowings and purchased funds at December 31, 2003 by $133.7 million or 18.1%. This was primarily due to increases in subordinated debt from the issuance of various trust preferred securities in the first half of 2004, an increase in long-term debt from the Peoples First, Inc. acquisition, and as part of the Company’s interest rate risk management strategy during that time.

A summary of each category of short-term borrowings for 2005, 2004 and 2003 follows (dollars in thousands):

	At or for the year ended December 31,
	2005			2004			2003
Securities sold under repurchase agreements and federal funds purchased
Balance at year-end	$	419,976		$	504,051		$	500,038
Average during the year		553,872			501,781			324,492
Maximum month-end balance		736,872			635,067			500,038
Weighted average rate during the year		2.44	%		1.24	%		1.22	%
Rate at December 31		2.63	%		1.79	%		1.08	%
Short-term borrowings
Balance at year-end	$	8,795		$	10,000		$	10,000
Average during the year		4,936			5,077			5,179
Maximum month-end balance		10,000			10,093			10,045
Weighted average rate during the year		2.88	%		1.08	%		0.77	%
Rate at December 31		4.00	%		1.87	%		0.59	%

38

The following table presents average balances, average rates and interest rate spread information for the years ended December 31, 2005, 2004 and 2003:

Average Balances, Average Rates and Interest Rate Spread*

(Dollars in thousands)

	Year Ended December 31,
	2005								2004								2003
	Average					Average			Average					Average			Average					Average
	Balance			Interest		Rate			Balance			Interest		Rate			Balance			Interest		Rate
INTEREST EARNING ASSETS:
Interest bearing deposits at banks	$	7,629		$	174		2.28	%	$	6,995		$	83		1.19	%	$	4,179		$	60		1.44	%
U.S. Treasury		10,578			270		2.55			9,721			205		2.11			721			50		6.93
U.S. Government agencies		792,207			31,737		4.01			660,528			27,183		4.12			430,225			19,044		4.43
State and municipal*		265,060			21,156		7.98			268,348			19,681		7.33			266,259			19,829		7.45
Other bonds and securities		75,904			3,575		4.71			61,958			3,122		5.04			71,345			3,415		4.79
Total investments		1,143,749			56,738		4.96			1,000,555			50,191		5.02			768,550			42,338		5.51
Federal funds sold		1,354			58		4.28			7,788			84		1.08			44,320			492		1.11
Trading account securities		-			-		-			-			-		-			-			-		-
Commercial loans and lease financing*		2,351,433			157,103		6.68			2,037,361			123,364		6.06			1,536,739			97,782		6.36
Installment loans		333,216			20,871		6.26			270,628			16,490		6.09			245,451			16,677		6.79
Mortgage loans		290,758			16,869		5.8			288,801			16,896		5.85			254,657			16,349		6.42
Total loans and leases		2,975,407			194,843		6.55			2,596,790			156,750		6.04			2,036,847			130,808		6.42
Total earning assets		4,128,139		$	251,813		6.10	%		3,612,128		$	207,108		5.73	%		2,853,896		$	173,698		6.09	%
Allowance for loan and lease losses		(57,010	)							(54,803	)							(45,494	)
Non-interest earning assets		473,402								417,324								280,319
Assets from discontnued operations		-								-								144,427
Total assets	$	4,544,531							$	3,974,649							$	3,233,148
INTEREST BEARING LIABILITIES:
Interest bearing deposits	$	2,620,206		$	60,765		2.32	%	$	2,298,859		$	38,140		1.66	%	$	1,899,695		$	33,753		1.78	%
Securities sold under repurchase agree-
ments and federal funds purchased		553,872			13,496		2.44			501,781			6,246		1.24			324,492			3,964		1.22
Short-term borrowings		4,936			142		2.88			5,077			55		1.08			5,179			40		0.77
Long-term borrowings		375,124			19,534		5.21			316,659			16,053		5.07			232,169			13,342		5.75
Total interest bearing liabilities		3,554,138		$	93,937		2.64	%		3,122,376		$	60,494		1.94	%		2,461,535		$	51,099		2.08	%
Non-interest bearing deposits		511,620								460,759								344,911
Other non-interest bearing liabilities		42,171								29,817								28,723
Liabilities from discontinued operations		-								-								130,392
Total liabilities		4,107,929								3,612,952								2,965,561
Equity capital		436,602								361,697								267,587
Total liabilities and equity capital	$	4,544,531							$	3,974,649							$	3,233,148
INTEREST RATE MARGIN**				$	157,876		3.82	%				$	146,614		4.06	%				$	122,599		4.30	%
Tax equivalent interest					9,227		0.22	%					8,333		0.23	%					8,050		0.28	%
Net interest income				$	148,649		3.60	%				$	138,281		3.83	%				$	114,549		4.01	%

*Full taxable equivalent basis, using a 35% effective tax rate.

**Represents the difference between interest earned and interest paid, divided by total earning assets.

Loan outstandings, net of unearned income, include non-accruing loans.

Fee income included.

39

SHAREHOLDERS’ EQUITY

Shareholders’ equity increased $16.8 million from December 31, 2004 through December 31, 2005 to $444.9 million. Retained earnings increased $31.8 million due to the retention of net income, partially offset by cash dividends declared, in 2005. Accumulated other comprehensive income decreased $16.7 million due to a decrease in market values of available for sale investment securities. Cash dividends paid in 2005 increased $2.8 million or 11.0% to $28.0 million compared to the cash dividends paid during 2004. Earnings retained during 2005 were 53.2% compared to 47.4% during 2004. The Company split its common stock five-for-four effective September 30, 2005.

RESULTS OF OPERATIONS

The Company recorded a 24.7% increase in net income to $59.8 million in the year ended December 31, 2005, compared to net income of $47.9 million in the year ended December 31, 2004. Diluted earnings per share increased $0.21 or 18.3% for the year ended December 31, 2005 to $1.36 per share from $1.15 in the year ended December 31, 2004 and $1.14 in the year ended December 31, 2003. The difference in the percentage increase in net income when compared to the percentage increase in diluted earnings per share is due to the larger number of weighted average common shares outstanding, principally resulting from the issuance of 3,893,062 shares of common stock for the acquisition of Peoples First, Inc. which was completed on June 10, 2004. Net income for 2004 of $47.9 million was 10.4% more than the $43.4 million reported in 2003. On a per share basis, basic earnings were $1.38, $1.17 and $1.17 for 2005, 2004, and 2003 respectively.

Included in net income for year ended 2005 was a recovery of $2.28 million, net of taxes, on the 2004 fraud loss. Also included in 2005 net income are expenses of $1.2 million, net of taxes, for legal, auditing and other investigation-related services, for a net impact from the fraud of $1.1 million on 2005 net income. Included in net income for 2004 was a special charge of $3.369 million, net of taxes and related adjustments, for losses attributable to the fraudulent loan and deposit scheme discovered by National Penn in January 2005. Excluding the fourth quarter 2004 special charge, non-GAAP net income and earnings per diluted share for 2004 were $51.3 million and $1.23, respectively. For additional information on this fraud loss, see Item 3. “Legal Proceedings”.

For the year ended December 31, 2005, the return on average shareholders’ equity and return on average assets were 13.7% and 1.31% compared to 13.2% and 1.20% for 2004.

Non-GAAP return on average tangible equity for the year ended December 31, 2005 was 25.8%, compared to 23.8% for 2004.

This Report contains supplemental financial information determined by methods other than in accordance with Accounting Principles Generally Accepted in the United States of America (“GAAP”). National Penn’s management uses these non-GAAP measures in its analysis of the Company’s performance. Non-GAAP net income and earnings per share exclude other significant gains, losses or expenses that are unusual in nature and not expected to recur. Because these items are not necessarily representative of underlying trends in the Company’s performance, management believes that presentation of financial measures excluding the impact of these items provides useful supplemental information that is essential to a proper understanding of the operating results of the Company’s core businesses. This also facilitates comparisons with prior or subsequent comparable periods. Another non-GAAP financial measure, 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. These disclosures should not be viewed as substitutes for results determined in accordance with GAAP, nor are they necessarily comparable to non-GAAP performance measures that may be presented by other companies.

40

The following table reconciles these non-GAAP performance measures to the most similar GAAP performance measures:

Reconciliation Table for Non-GAAP Financial Measures:

				2004
Net income, excluding special charge for fraud loss and compensation expense adjustment, net of taxes (in millions)				$	51.3
Special charge for fraud loss, net of taxes (in millions)					(4.3	)
Compensation expense adjustment, net of taxes (in millions)					.9
Net income (in millions				$	47.9
Diluted earnings per share, excluding special charge for fraud loss and compensation expense adjustment, net of taxes				$	1.23
Special charge for fraud loss, net of taxes, per share					(.10	)
Compensation expense adjustment, net of taxes, per share					.02
Diluted earnings per share				$	1.15
	2005			2004
Return on average shareholders’ equity		13.7	%		13.2	%
Effect of special charge for fraud loss, net of taxes		-			1.2	%
Effect of compensation expense adjustment, net of taxes		-			(.3	)%
Return on average shareholders’ equity, excluding special
charge for fraud loss and compensation expense adjustment,
net of taxes		13.7	%		14.1	%
		2005			2004
Return on average shareholders' equity		13.7	%		13.2	%
Effect of goodwill and intangibles		12.1	%		10.6	%
Return on average tangible equity		25.8	%		23.8	%
Effect of special charge for fraud loss, net of taxes		-			2.2	%
Effect of compensation expense adjustment, net of taxes		-			(.5	)%
Return on average tangible equity, excluding special charge for
fraud loss and compensation expense adjustment, net of taxes		25.8	%		25.5	%
Average tangible equity excludes acquisition-related average
goodwill and intangibles:
Average shareholders’ equity (in millions)	$	436.6		$	361.7
Average goodwill and intangibles (in millions)		(205.0	)		(160.3	)
Average tangible equity (in millions)	$	231.6		$	201.4

41

Net interest income is the difference between interest income on assets and interest expense on liabilities. Net interest income increased $10.4 million or 7.5% to $148.6 million in 2005 from the 2004 amount of $138.2 million. Interest income increased $43.8 million or 22.0% to $242.6 million in 2005, as compared to $198.8 million in 2004, as a result of an increase in loan interest income of $37.7 million and an increase in investment securities interest income of $6.1million. Interest expense in 2005 increased $33.4 million or 55.3% to $93.9 million from the 2004 amount of $60.5 million due to an increase in interest on deposits of $22.6 million, an increase in interest on long-term borrowings of $3.5 million, and an increase in expense for securities sold under repurchase agreements and federal funds sold of $7.3 million. The increase in interest expense on deposits is due primarily to an increase in interest bearing deposits and the average rate paid on these deposits in 2005. The increase in interest expense on borrowings is a result of an increase in the average balance of borrowings outstanding during 2005 and an increase in the average rate on borrowings in the repurchase agreement and federal funds sold category.

The cost of attracting and holding deposited funds is an ever-increasing expense in the banking industry. These increases are the real costs of deposit accumulation and retention, including FDIC insurance costs, marketing and community office overhead expenses. Such costs are necessary for continued growth and to maintain and increase market share of available deposits.

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).

42

For purposes of the following table, 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. Net interest income, on a taxable equivalent basis, increased $11.3 million in the year ended December 31, 2005, as compared to 2004. This increase is due to a $19.8 million increase in the volume of interest earning assets, offset by an $8.6 million net interest margin compression.

	(in thousands)
	Year Ended December 31,
	2005 over 2004 (1)									2004 over 2003 (1)
Increase (decrease) in:	Volume			Rate			Total			Volume			Rate			Total
Interest income:
Interest bearing deposits at banks	$	8		$	83		$	91		$	41		$	(17	)	$	24
Securities:
US Treasury and Agencies		5,416			(797	)		4,619			10,602			(2,309	)		8,293
State and municipal		(241	)		1,716			1,475			156			(304	)		(148	)
Other bonds and securities		703			(250	)		453			(449	)		156			(293	)
Total investment securities		5,878			669			6,547			10,310			(2,457	)		7,853
Federal funds sold		(69	)		43			(26	)		(406	)		(2	)		(408	)
Loans:
Comml loans and lease financing		19,017			14,722			33,739			31,854			(6,272	)		25,582
Installment loans		3,814			567			4,381			1,711			(1,898	)		(187	)
Mortgage loans		114			(141	)		(27	)		2,192			(1,645	)		547
Total loans		22,945			15,148			38,093			35,757			(9,815	)		25,942
Total interest income	$	28,762		$	15,943		$	44,705		$	45,702		$	(12,292	)	$	33,410

Interest Expense:
Interest bearing deposits		5,331			17,294			22,625		7,091			(2,705	)		4,388
Securities sold under repurchase agreements and federal funds purchased		648			6,602			7,250		2,166			116			2,282
Short-term borrowings		(2	)		89			87		(1	)		16			15
Long-term borrowings		2,964			517			3,481		4,853			(2,144	)		2,709
Total borrowed funds		3,610			7,208			10,818		7,018			(2,012	)		5,006
Total interest expense	$	8,941		$	24,502		$	33,443	$	14,111		$	(4,717	)	$	9,394
Increase (decrease) in net interest income	$	19,821		$	(8,559	)	$	11,262	$	31,591		$	(7,575	)	$	24,016

(1) Variance not solely due to rate or volume is allocated to the volume variance. The change in interest due to both rate and volume is allocated to rate and volume changes in proportion to the relationship of the absolute dollar amounts of the change in each.

Net interest margin is net interest income divided by total interest earning assets. During 2005, net interest margin was 3.82%, compared to 4.06% during 2004 and 4.30% during 2003. The decline in the net interest margin from the 2004 margin is attributable to continued competitive pressures and general overall margin compression.

ALLOWANCE FOR LOAN AND LEASE LOSSES

The provision for loan and lease losses is determined by periodic reviews of loan quality, current economic conditions, loss experience and loan growth. Based on these factors, the provision for loan and lease losses was $3.2 million for the year ended December 31, 2005 and $4.8 million and $9.4 million for the years ended December 31, 2004 and 2003, respectively. The allowance for loan and lease losses of $56.1 million at year-end 2005 and $57.6 million at year-end 2004 as a percentage of total loans was 1.84% at year-end 2005 and 2.00% at year-end 2004.

Net loan chargeoffs were $4.7 million in 2005. Net loan chargeoffs of $2.6 million in 2004 were unusually low compared to historical Company results. Net loan chargeoffs of $6.8 million in 2003 were typical compared to historical Company results. Management continues to believe its loan loss allowance is adequate to cover losses inherent in the current portfolio.

43

A detailed analysis of the Company’s allowance for loan and lease losses for the five years ended December 31, 2005, is shown below (dollars in thousands):

	December 31,
	2005			2004			2003			2002			2001
Balance at beginning of year	$	57,590		$	49,265		$	40,578		$	40,449		$	37,724
Charge-offs:
Commercial and industrial loans and leases		4,239			3,388			8,066			2,795			1,566
Real estate loans:
Construction and land development		-			-			75			7,393			1,708
Residential		1,961			1,070			611			2,679			1,852
Other		656			941			1,277			512			436
Loans to individuals		389			218			2,315			1,986			1,960
Total Charge-offs		7,245			5,617			12,344			15,365			7,522
Recoveries:
Commercial and industrial		1,650			1,860			3,556			166			957
Real estate loans:
Construction and land development		1			332			537			7			56
Residential		299			647			348			794			339
Other		497			55			784			245			252
Loans to individuals		72			84			272			697			193
Total Recoveries		2,519			2,978			5,497			1,909			1,797
Net Charge-offs		4,726			2,639			6,847			13,456			5,725
Provision charged to expense		3,200			4,800			9,371			13,585			8,450
Adjustments:
Changes incident to mergers, net		-			6,164			6,163			-			-
Balance at end of year	$	56,064		$	57,590		$	49,265		$	40,578		$	40,449
Ratio of net charge-offs during the period to average loans outstanding during the period		0.16	%		0.10	%		0.34	%		0.77	%		0.33	%

Commercial and industrial loans, real estate loans, and construction loans are charged off to the allowance as soon as it is determined that the repayment of all or part of the principal balance is highly unlikely. Loans to individuals are charged off any time repayment is deemed highly unlikely or as soon as the loan becomes 120 days delinquent.Because all identified losses are immediately charged off, no portion of the allowance for loan and lease losses is restricted to any individual loan or groups of loans, and the entire allowance is available to absorb any and all loan and lease losses.

The Company maintains an allowance for loan and lease losses at a level deemed sufficient to absorb losses, which are inherent in the loan portfolio at each balance sheet date. Management reviews the adequacy of the allowance on at least a quarterly basis to ensure that the provision for loan and lease losses has been charged against earnings in an amount necessary to maintain the allowance at a level that is appropriate based on management’s assessment of probable estimated losses. The Company’s methodology for assessing the appropriateness of the allowance for loan and lease losses consists of several key elements. These elements include a specific reserve for doubtful or high risk loans, an allocated reserve based on historical trends, and an unallocated portion. The Company consistently applies the following comprehensive methodology.

44

The specific reserve for high risk loans is established for specific commercial and industrial loans, real estate development loans, and construction loans which have been identified by bank management as being high risk loan assets. These high risk loans are assigned a doubtful risk rating grade because the loan has not performed according to payment terms and there is reason to believe that repayment of the loan principal in whole or part is unlikely. The specific portion of the allowance is the total amount of potential unconfirmed losses for these individual doubtful loans. To assist in determining the fair value of loan collateral, the Company often utilizes independent third party qualified appraisal firms which in turn employ their own criteria and assumptions that may include occupancy rates, rental rates, and property expenses, among others.

The second category of reserves consists of the allocated portion of the allowance. The allocated portion of the allowance is determined by taking pools of loans outstanding that have similar characteristics and applying historical loss experience for each pool. This estimate represents the potential unconfirmed losses within the portfolio. Individual loan pools are created for commercial loans, real estate development and construction loans, and for the various types of loans to individuals. The historical estimation for each loan pool is then adjusted to account for current conditions, current loan portfolio performance, loan policy or management changes or any other factor, which may cause future losses to deviate from historical levels. Before applying the historical loss experience percentages, loan balances are reduced by the portion of the loan balances, if any, which are subject to a guarantee by a government agency.

The Company also maintains an unallocated allowance. The unallocated allowance is used to cover any factors or conditions which may cause a potential loan loss but are not specifically identifiable. It is prudent to maintain an unallocated portion of the allowance because no matter how detailed an analysis of potential loan losses is performed, these estimates by definition lack precision. Management must make estimates using assumptions and information, which is often subjective and changing rapidly. At December 31, 2005, management believes that the allowance for loan losses and nonperforming loans remained safely within acceptable levels.

During the quarterly review of the allowance for loan and lease losses, the Company considers a variety of factors that include:

· General economic conditions.

· Trends in charge-offs.

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

· Levels of allowance for specific classified assets.

· A review of portfolio concentration of any type, either customer, industry loan type, collateral or risk grade.

45

The following table shows how the allowance for loan and lease losses is allocated among the various types of loans and leases that the Company has outstanding. This allocation is based on management’s specific review of the credit risk of the outstanding loans and leases in each category as well as historical trends.

Allocation of the Allowance for Loan and Lease Losses (1)(2) (dollars in thousands)
	2005					2004					2003					2002					2001
			% Loan					% Loan					% Loan					% Loan					% Loan
			Type to					Type to					Type to					Type to					Type to
			Total					Total					Total					Total					Total
	Allowance		Loans			Allowance		Loans			Allowance		Loans			Allowance		Loans			Allowance		Loans
Commercial and industrial	$	12,479		23.2	%	$	11,951		21.7	%	$	9,884		21.3	%	$	7,727		19.9	%	$	6,331		19.3	%
Real estate loans:
Construction and land dev.		3,630		6.8	%		3,855		7.0	%		3,061		6.6	%		2,651		6.9	%		2,375		7.2	%
Residential		18,991		35.4	%		19,606		35.6	%		15,453		33.2	%		14,707		37.9	%		12,001		36.6	%
Other		17,526		32.6	%		18,284		33.2	%		16,965		36.5	%		12,469		32.2	%		10,628		32.4	%
Loans to individuals		1,069		2.0	%		1,377		2.5	%		1,115		2.4	%		1,200		3.1	%		1,463		4.5	%
Unallocated		2,369		N/A			2,517		N/A			2,787		N/A			1,824		N/A			7,651		N/A
	$	56,064		100.0	%	$	57,590		100.0	%	$	49,265		100.0	%	$	40,578		100.0	%	$	40,449		100.0	%

(1)	This allocation is made for analytical purposes. The total allowance is available to absorb losses from any segment of the portfolio.
(2)	The classification of loans in the above table corresponds to defined bank regulatory reporting categories and is presented for analytical purposes. Internal classification of loans is described in Item 1., “Lending”, of this Report.

OTHER INCOME AND EXPENSES

Other income increased $10.2 million or 21.9% in 2005 compared to 2004, primarily as a result of increased insurance commissions and fees of $3.3 million, other service charges and fees of $2.3 million, mortgage banking income of $1.5 million, and cash management and electronic banking fees of $1.1 million. 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 deposit fees was primarily due to an increase in the collection of fees on a larger deposit base resulting from the Peoples First, Inc. acquisition in June 2004. Mortgage banking income increased due to increased mortgage origination volume resulting from low long-term interest rates. Gains on the sale of investment securities were primarily due to the sale of equity securities in the second and third quarters of 2005. The increase in other income also includes a one-time gain on the sale of the Peoples Bank of Oxford operations center in the first quarter of 2005.

The increase in other income in 2004 compared to 2003 was $5.5 million or 13.3% as a result of increased service charges on deposits accounts of $3.2 million, increased other service charges and fees, including cash management, of $430,000, and increased insurance commissions and fees of $1.1 million. The increase in deposit fees is due primarily to an increase in the collections of fees on a larger deposit base, resulting from the Peoples First acquisition. In 2004 bank owned life insurance income increased by $135,000. Mortgage banking income decreased by $1.3 million due to the slowdown in refinance volume throughout 2004. Net gains on sales of investment securities was $549,000 in 2004, as compared to a loss on sale of investment securities of $369,000 in 2003.

46

Other expenses increased $5.6 million or 4.8% in 2005 when compared to 2004, as a result of increased salaries, wages and benefits of $10.6 million, and increased other operating expenses of $1.6 million. Salaries, wages and benefits increased due to normal salary increases and increases in benefit costs, as well as the addition of employees from the 2005 acquisitions of Krombolz and Preferred Insurance Assoc. insurance agencies. Other operating expenses increased due to the aforementioned 2005 acquisitions of Krombolz and Preferred Insurance Assoc. and the Peoples First, Inc. acquisition in June 2004. These increases were offset by an $8.3 million reduction in special charges for fraud loss as a result of decreased professional fees and the special recovery of $3.5 million recorded in the fourth quarter 2005.

Other expenses increased $14.5 million or 14.1% in 2004 compared to 2003 as a result of increased salaries, wages and benefits of $8.0 million, increased net premises and equipment expense of $2.3 million, increased advertising and marketing expense of $727,000, and a fraud loss of $6.7 million. Salaries, wages and benefits increased due to normal salary increases and the addition of 137 employees from the acquisition of Peoples First. Net premises and equipment expense increased due to the addition of 9 community offices acquired in the June 10, 2004 acquisition of Peoples First, Inc. Advertising and marketing expense increased due to the roll-out of a new name identification advertising campaign.

For 2005, 2004, and 2003, there are no individual items of other expenses that exceed one percent of the aggregate of total interest income and other income, with the exception of advertising and marketing related expenses, and a $7.0 million non-recurring FHLB prepayment fee in 2003.

Income before income taxes increased $16.6 million or 26.4% in 2005 compared to 2004, due primarily to organic growth, the acquisitions in 2005 of two insurance agencies, Krombolz Agency, Inc. and Preferred Insurance Associates, and the Peoples First, Inc. acquisition in June 2004. Income before income taxes increased $19.3 million or 44.5% in 2004 compared to 2003, due primarily to organic growth and the acquisition of Peoples First, Inc.

In 2005 and 2004, there was no income from discontinued operations. In 2003, income from discontinued operations, net of taxes, was $8.6 million on the gain on sale of Panasia Bank in that year.

Income taxes increased $4.8 million or 32.0% in 2005 and increased $6.2 million in 2004 as compared to 2003, or 70.8%. The Company’s effective tax rate is 24.7% for 2005, and was 23.7% for 2004, and 20.0% for 2003. The increase in the effective tax rate from 2003 to 2004 was due to the decrease in tax advantaged income as a percent of taxable income. The effective tax rate is less than the current 35% incremental rate due to the Company’s investments in tax advantaged municipal securities and bank owned life insurance.

47

LIQUIDITY AND INTEREST RATE SENSITIVITY

The primary functions of asset/liability management are to assure adequate liquidity and maintain an appropriate balance between interest-earnings 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 2003, the Company’s liquidity position was strong as people removed money from the declining equity market. At that time, many customers preferred the safety of FDIC-insured deposits compared to the uncertain equity market, despite historically low interest rates. This allowed the Company to grow its core deposit base and significantly reduce reliance on non-core sources of funds during 2003. In 2004, as the economy started to improve, the Company’s liquidity was not as strong as in 2003, but liquidity was clearly adequate to meet the needs of the Company’s customers.

As the economy and equity markets continued to improve during 2005, liquidity became more challenging. More customers were willing to move their money back into the equity market, businesses were investing their cash balances into their business, thereby reducing their deposits in the bank, and loan demand improved. As the liquidity needs of banking customers increased, the competition in the banking industry increased. This competition for deposits was especially heightened in our marketplace by the formation of a number of new banks.

In addition to this general challenging environment, liquidity was further affected during the first seven months of 2005 as deposits from government entities, especially school districts, experienced their seasonal decline. School district deposits typically materialize in August and September as school districts receive their tax funding. The funds then typically reduce during the next twelve months as the school districts use the money to pay expenses, reaching a low point by the end of July or early August. Then in mid-to-late August, the cycle begins again. We also experience this phenomenon with local government entities from March through February, but the amount of local government entity deposits is smaller so the affect is lessened.

The Company successfully met this liquidity challenge in 2005 through a variety of tactics, including: proactively marketing deposits to commercial customers with larger deposits, using the Company’s marketing software to identify retail customers with a high propensity to move additional deposits to the Company, and then marketing directly to those customers. Developing new deposit products such as the Prime Rate Certificate of Deposit, offering a Certificate of Deposit promotion in August which netted over $100 million in new deposits, using brokered deposits, selling all fixed-rate mortgage production (we had typically held 10-year and 15-year mortgage production), using our ample availability of borrowed funds from correspondent banks and the Federal Home Loan Bank, and using the cash flow from the investment portfolio. Through it all, deposits increased 5.28% from 2004 to 2005. While borrowed funds were used to help offset the seasonal outflow of the school district deposits during the year, by the end of 2005, borrowed funds were 7.67% lower than the end of 2004.

We expect that the challenging liquidity environment will continue into 2006 and that the competition for deposits will become even more intense. We will continue to monitor our liquidity position closely and we will use much the same tactics in 2006 as we used to successfully meet the challenge in 2005.

48

The following table shows separately the interest rate sensitivity of each category of interest earning assets and interest bearing liabilities at December 31, 2005 (in thousands):

	Repricing Periods
	Within Three Months			Three Months Through One Year			One Year Through Five Years		Over Five Years
Assets
Interest bearing deposits at banks	$	5,937		$	-		$	-	$	-
Federal funds sold		-			-			-		-
Investment securities		59,787			116,424			641,138		274,365
Loans and leases (1)		1,253,740			254,518			1,058,508		426,978
Other assets		-			-			-		509,214
		1,319,464			370,942			1,699,646		1,210,557
Liabilities and equity
Non-interest bearing deposits		5,355			11,167			131,718		361,681
Interest bearing deposits (2)		1,061,670			527,688			462,959		746,808
Borrowed funds (3)		233,119			36,500			116,888		290,676
Subordinated debt		61,857			-			-		65,206
Other liabilities		-			-			-		42,429
Shareholders’ equity		-			-			-		444,888
		1,362,001			575,355			711,565		1,951,688
Interest sensitivity gap		(42,537	)		(204,413	)		988,081		(741,131	)
Cumulative interest rate sensitivity gap	$	(42,537	)	$	(246,950	)	$	741,131	$	-

(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 fourth calendar quarter of 2004. 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, 50.0% of these deposits are considered repriceable within three months and 50.0% are considered repriceable in the over five-year category.
(3)	Includes federal funds purchased, securities sold under repurchase agreements, and short and long term borrowings.

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 increase in a falling interest rate environment and would decrease in a rising interest rate environment. An interest rate gap table does not, however, present a complete picture of the impact of 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 of 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.

49

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 December 31, 2005 are as follows (dollars in thousands):

MVPE

Change in Interest Rate	Amount		% Change
+300 Basis Points	$	566,319		-6.7	%
+200 Basis Points		561,338		-7.5
+100 Basis Points		581,966		-4.2
Flat Rate		607,145		-
-100 Basis Points		622,830		2.6
-200 Basis Points		643,156		5.9
-300 Basis Points		642,000		5.7

Management believes that the assumptions utilized in evaluating the vulnerability of the Company’s earnings and capital to changes in interest rates approximate actual experience; however, the interest rate sensitivity of the Company’s assets and liabilities as well as the estimated effect of changes in interest rates on MVPE could vary substantially if different assumptions are used, such as 400 or 500 basis point changes in interest rates, or actual experience differs from the experience on which the assumptions were based.

If the Company should experience a mismatch in its desired gap ranges or an excessive decline in its MVPE subsequent to an immediate and sustained change in interest rate, it has a number of options which it could utilize to remedy such mismatch. The Company could restructure its investment portfolio through the sale or purchase of securities with more favorable repricing attributes. It could also emphasize loan products with appropriate maturities or repricing attributes, or it could emphasize deposits or obtain borrowings with desired maturities.

The Company anticipates a continuing inverted yield curve during 2006. This is a particularly challenging environment that has the effect of squeezing the Company’s net interest margins. Given this assumption, the Company’s asset/liability strategy for 2006 is to maintain a fairly balanced interest rate risk position. This is intended to position the Company to react appropriately whenever the inverted yield curve normalizes, and to lessen the impact of changing interest rates on net interest income. Effective monitoring of interest rate risk is the priority of the Company’s Asset/Liability Management Committee.

50

CONTRACTUAL OBLIGATIONS AND OTHER COMMITMENTS

The following table sets forth contractual obligations and other commitments representing required and potential cash outflows as of December 31, 2005 (in thousands):

	Total		Less than  One Year		One to Three Years		Four to Five Years		After Five Years
Minimum annual rentals on non-cancelable operating leases	$	22,565	$	3,427	$	5,192	$	3,893	$	10,053
Remaining contractual maturities of time deposits		1,257,769		790,144		408,047		56,888		2,690
Loan commitments		1,024,218		626,652		55,196		33,680		308,690
Long-term borrowed funds		248,412		36,586		74,500		42,387		94,939
Guaranteed preferred beneficial interests in Company’s subordinated debentures		127,063		-		-		-		127,063
Letters of credit		95,987		57,242		35,626		3,046		73
Total	$	2,776,014	$	1,514,051	$	578,561	$	139,894	$	543,508

The Company had no capital leases at December 31, 2005.

CAPITAL ADEQUACY

The following table sets forth certain capital performance ratios for the Company. We retain approximately 50% of our earnings in the form of capital to support future growth.

	2005	2004	2003
CAPITAL PERFORMANCE
Return on average assets	1.31%	1.20%	1.34%
Return on average equity	13.7%	13.2%	16.2%
Dividend payout ratio	46.82%	52.59%	48.98%
Earnings retained	53.18%	47.41%	51.02%

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

	CAPITAL LEVELS
	Tier 1 Capital to		Tier 1 Capital to Risk-		Total Capital to Risk-
	Average Assets Ratio		Weighted Assets Ratio		Weighted Assets Ratio
	December 31
	2005	2004	2005	2004	2005	2004
The Company	8.36%	7.86%	10.47%	10.02%	11.81%	11.27%
National Penn Bank	7.43%	7.00%	9.35%	8.93%	10.60%	10.19%
Well capitalized institution	5.00%	5.00%	6.00%	6.00%	10.00%	10.00%

(under banking regulations)

51

The capital ratios set forth 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 December 31, 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%. At December 31, 2005, National Penn Bank met 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.

The Company does not presently have any commitments for significant capital expenditures. The Company is experiencing a space shortage and is planning construction of an operations facility. In 2005, the Company acquired a tract of land in Amity Township, Berks County, Pennsylvania, for this purpose. The land use township approval process for an operations center of up to 70,000 square feet is currently pending.

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

On December 21, 2005, the Company’s Board or Directors authorized the repurchase of up to 2 million shares of the Company’s common stock to be used to fund the Company’s dividend reinvestment plan, stock compensation plans, stock-based benefit plans, and employee stock purchase plan. No timetable was set for these repurchases, but none will be made until completion of the repurchase program approved in September 2003.

On September 24, 2003, the Company’s Board of Directors authorized the repurchase of up to 1,562,000 shares of the Company’s common stock (adjusted for the five-for-four stock split effective 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. As of December 31, 2005, 1,293,618 shares have been repurchased at an average price of $24.35 under the 2003 repurchase plan.

The foregoing information on stock repurchases is adjusted for the 5% stock dividend in 2003 and the five-for-four stock splits in 2004 and 2005.

NEW ACCOUNTING PRONOUNCEMENTS

Information on new accounting pronouncements is set forth in Footnote 1 to the Consolidated Financial Statements included in this Report at Item 8. This information is incorporated herein by reference.

FUTURE OUTLOOK

The Company’s market area, while diverse, is subject to many of the same economic forces being experienced regionally and nationally:

· The general economy will likely generate loan growth in 2006 in the high single-digit percentages.

· The principal challenge faced by the Company today is to grow our earnings in light of the compression of our net interest margin due to current and anticipated interest rate levels. 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, especially revenues from insurance and wealth management activities. We anticipate continued pressure on net interest margin through 2006.

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.

52

Item 7A. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK.

Information with respect to quantitative and qualitative disclosures about market risk is included in the information under Management’s Discussion and Analysis at Item 7 in this Report.

53

Item 8. FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA.

NATIONAL PENN BANCSHARES, INC. AND SUBSIDIARIES

Consolidated Balance Sheets

(dollars in thousands, except per share data)

	December 31,
	2005			2004
ASSETS
Cash and due from banks	$	116,522		$	85,118
Interest bearing deposits in banks		5,937			8,776
Total cash and cash equivalents		122,459			93,894
Investment securities held to maturity		150,608			90,967
Investment securities available for sale, at fair value		941,106			1,098,836
Loans and leases held for sale		18,583			11,801
Loans and leases, less allowance for loan and lease losses of $56,064
and $57,590 in 2005 and 2004, respectively		2,975,161			2,805,048
Premises and equipment, net		53,158			53,719
Accrued interest receivable		20,019			17,823
Bank owned life insurance		82,688			79,545
Goodwill		187,995			186,945
Other intangibles		16,087			18,462
Unconsolidated investments under the equity method		3,849			3,854
Other assets		28,896			17,899
Total assets	$	4,600,609		$	4,478,793
LIABILITIES AND SHAREHOLDERS’ EQUITY
Deposits
Non-interest bearing	$	509,921		$	515,901
Interest-bearing		2,799,125			2,627,292
Total deposits		3,309,046			3,143,193
Securities sold under repurchase agreements and federal funds purchased		419,976			504,051
Short-term borrowings		8,795			10,000
Long-term borrowings		248,412			229,926
Subordinated debt		127,063			127,063
Accrued interest payable and other liabilities		42,429			36,435
Total liabilities		4,155,721			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 - 43,381,790; 2004 - 43,138,498, net of shares
in Treasury: 2005 - 275,431; 2004 - 109,950		366,877			362,007
Retained earnings		80,267			48,485
Accumulated other comprehensive income		3,189			19,915
Treasury stock, at cost		(5,445	)		(2,282	)
Total shareholders’ equity		444,888			428,125
Total liabilities and shareholders’ equity	$	4,600,609		$	4,478,793

The accompanying notes are an integral part of these statements.

54

NATIONAL PENN BANCSHARES, INC. AND SUBSIDIARIES

Consolidated Statements of Income

(dollars in thousands, except per share data)

	Year ended December 31,
	2005			2004			2003
INTEREST INCOME
Loans and leases, including fees	$	192,795		$	155,105		$	129,569
Investment securities
Taxable		35,581			30,509			22,510
Tax-exempt		13,978			12,993			13,017
Federal funds sold		58			84			492
Deposits in banks		174			84			60
Total interest income		242,586			198,775			165,648
INTEREST EXPENSE
Deposits		60,765			38,141			33,753
Securities sold under repurchase agreements and federal funds purchased		13,496			6,246			3,964
Short-term borrowings		142			55			40
Long-term borrowings		19,534			16,051			13,342
Total interest expense		93,937			60,493			51,099
Net interest income		148,649			138,282			114,549
Provision for loan and lease losses		3,200			4,800			9,371
Net interest income after provision for loan and lease losses		145,449			133,482			105,178
NON-INTEREST INCOME
Wealth management income		9,076			8,492			7,705
Service charges on deposit accounts		16,146			15,230			12,099
Bank owned life insurance income		3,447			3,725			3,590
Other service charges and fees		6,854			4,545			4,504
Net gains (losses) on sale of investment securities		555			(84	)		(369	)
Mortgage banking income		5,366			3,829			5,146
Insurance commissions and fees		6,970			3,704			2,654
Cash management and electronic banking fees		7,680			6,574			5,690
Equity in undistributed net earnings of affiliates		-			759			266
Gain on sale of building		922			-			-
Total non-interest income		57,016			46,774			41,285
NON-INTEREST EXPENSES
Salaries, wages and employee benefits		74,742			64,159			56,181
Net premises and equipment		17,652			16,451			14,133
Advertising and marketing expense		4,845			4,331			3,604
FHLB prepayment fee		46			-			7,002
Special (recovery) charge for fraud loss, net of expenses		(1,603	)		6,684			-
Other operating expenses		27,421			25,866			22,113
Total non-interest expenses		123,103			117,491			103,033
Income before income taxes		79,362			62,765			43,430
Income taxes		19,607			14,851			8,697
Net income from continuing operations		59,755			47,914			34,733
Net income from discontinued operations, net of taxes		-			-			8,621
NET INCOME	$	59,755		$	47,914		$	43,354
PER SHARE OF COMMON STOCK
Basic earnings	$	1.38		$	1.17		$	1.17
Diluted earnings	$	1.36		$	1.15		$	1.14
Dividends paid in cash	$	0.645		$	0.621		$	0.574
The accompanying notes are integral part of these statements.

55

NATIONAL PENN BANCSHARES, INC. AND SUBSIDIARIES

Consolidated Statement of Changes in Shareholders’ Equity

(dollars in thousands)

	Common						Retained			Accumulated other comprehensive			Treasury						Compre- hensive
	Shares			Par Value			earnings			income			stock			Total			income
Balance at January 1, 2003		20,699,782		$	172,471		$	30,593		$	19,296			-		$	222,360
Net income		-			-			43,354			-			-			43,354		$	43,354
Cash dividends declared		-			-			(16,475	)		-			-			(16,475	)
5% stock dividend		1,152,796			31,702			(31,702	)		-			-			-
Shares issued under stock based           plans		66,884			4,890			-			-			-			4,890
Shares issued for acquisition of
FirstService Bank		2,563,337			68,726			-			-			5,610			74,336
Valuation of stock options for
acquisition of HomeTowne
Heritage Bank		-			4,388			-			-			-			4,388
Other comprehensive income, net
of reclassification adjustment
and taxes		-			-			-			299			-			299			299
Total comprehensive income		-			-			-			-			-			-		$	43,653
Purchase of treasury stock transactions		(198,293	)		(9,643	)		-			-			(5,696	)		(15,339	)
Balance at December 31, 2003		24,284,506			272,534			25,770			19,595			(86	)		317,813
Net income		-			-			47,914			-			-			47,914		$	47,914
Cash dividends declared		-			-			(25,199	)		-			-			(25,199	)
5-for4 stock split		6,905,251			-			-			-			-			-
Shares issued under stock based           plans		607,080			1,596			-			-			10,753			12,349
Shares issued for acquisition of           Peoples First, Inc. and           Pennsurance		3,048,637			87,877			-			-			(2,097	)		85,780
Other comprehensive income, net
of reclassification adjustment
and taxes		-			-			-			320			-			320			320
Total comprehensive income		-			-			-			-			-			-		$	48,234
Purchase of treasury stock transactions		(334,676	)		-			-			-			(10,852	)		(10,852	)
Balance at December 31, 2004		34,510,798			362,007			48,485			19,915			(2,282	)		428,125
Net income		-			-			59,755			-			-			59,755		$	59,755
Cash dividends declared		-			-			(27,973	)		-			-			(27,973	)
5 for 4 stock split		8,712,484			-			-			-			-			-
Shares issued under stock based           plans		558,933			4,870			-			-			5,234			10,104
Other comprehensive (loss), net of           reclassification adjustment and           taxes		-			-			-			(16,726	)		-			(16,726	)		(16,726	)
Total comprehensive income		-			-			-			-			-			-		$	43,029
Purchase of treasury stock transactions		(400,425	)		-			-			-			(8,397	)		(8,397	)
Balance at December 31, 2005		43,381,790		$	366,877		$	80,267		$	3,189		$	(5,445	)	$	444,888
The accompanying notes are an integral part of this statement.

56

NATIONAL PENN BANCSHARES, INC. AND SUBSIDIARIES

Consolidated Statements of Cash Flows (dollars in thousands, except per share data)

	Year Ended December 31
	2005			2004			2003
CASH FLOWS FROM OPERATING ACTIVITIES
Net Income     Adjustments to reconcile net income to net cash provided by operating activities	$	59,755		$	47,914		$	43,354
Provision for loan and lease losses		3,200			4,800			9,371
Depreciation and amortization		9,236			7,996			6,260
Deferred income tax expense		2,256			(2,569	)		2,895
Amortization of premiums and discounts on investment securities, net		(1,797	)		(1,047	)		319
Investment securities (gains) losses, net		(555	)		84			369
Mortgage loans originated for resale		(292,738	)		(135,544	)		(224,585	)
Sale of mortgage loans originated for resale		296,648			138,056			228,986
Gain on sale of mortgage loans originated for resale		(3,910	)		(2,512	)		(4,401	)
Gain on sale of building		(922	)
Changes in assets and liabilities
(Increase) decrease in accrued interest receivable		(2,196	)		(1,967	)		1,299
(Decrease) increase in accrued interest payable		7,406			3,807			(1,865	)
(Decrease) increase in other assets		(7,489	)		660			333
Increase (decrease) in other liabilities		(1,412	)		8,454			(64	)
Decrease (increase) in assets from discontinued operations(1)		-			-			22,122
Increase (decrease) in liabilities from discontinued operations(1)		-			-			(1,888	)
Net cash provided by operating activities		67,482			68,132			82,505
CASH FLOWS FROM INVESTING ACTIVITIES
Cash received for business sold		-			-			34,500
Cash paid in excess of cash equivalents for business acquired		(950	)		(35,205	)		(33,998	)
Proceeds from maturities of investment securities held to maturity		11,782			1,282			-
Purchase of investment securities held to maturity		(71,380	)		(92,249	)		-
Proceeds from sales of investment securities available for sale		46,303			56,299			34,663
Proceeds from maturities of investment securities available for sale		260,497			212,975			100,895
Purchase of investment securities available for sale		(172,488	)		(380,719	)		(347,742	)
Net increase in loans		(181,669	)		(243,917	)		(111,924	)
Purchases of premises and equipment		(7,405	)		(6,644	)		(9,507	)
Sale of bank building		3,600			-			-
Decrease (increase) in assets from discontinued operations(1)		-			-			185,153
Increase (decrease) in liabilities from discontinued operations(1)		-			-			(890	)
Net cash used in investing activities		(111,710	)		(488,178	)		(148,850	)
CASH FLOWS FROM FINANCING ACTIVITIES     Net (decrease) increase in interest and non-interest bearing demand
deposits and savings accounts		(229,967	)		210,742			138,495
Net (decrease) increase in certificates of deposit		395,820			114,664			(52,474	)
Net (decrease) increase in securities sold under agreements to repurchase and         federal funds purchased		(84,075	)		17,424			191,750
Net (decrease) in short-term borrowings		(1,205	)		-			(614	)
Proceeds from new long-term borrowings		85,500			50,000			70,000
Repayments of long-term borrowings		(67,014	)		(15,443	)		(82,854	)
Issuance of subordinated debentures		-			61,857			-
Shares issued under stock-based plans		10,104			12,349			794
Purchase of treasury stock		(8,397	)		(10,852	)		(15,339	)
Cash dividends		(27,973	)		(25,199	)		(21,234	)
Increase (decrease) in liabilities from discontinued operations(1)		-			-			(187,906	)
Net cash provided by financing activities		72,793			415,543			40,618
Net increase (decrease) in cash and cash equivalents		28,565			(4,503	)		(25,727	)
Cash and cash equivalents at beginning of year		93,894			98,397			124,124
Cash and cash equivalents at December 31	$	122,459		$	93,894		$	98,397
(1) Revised - See Footnote 1 in Item 8 of this Report.
The accompanying notes are integral part of these statements.

57

NATIONAL PENN BANCSHARES, INC. AND SUBSIDIARIES

Notes to Consolidated Financial Statements

December 31, 2005 and 2004

1.SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES

NATURE OF OPERATIONS

National Penn Bancshares, Inc. (the “Company” or “National Penn”), primarily through its national bank subsidiary, National Penn Bank (NPB), and NPB’s divisions, the FirstService Bank, HomeTowne Heritage Bank and The Peoples Bank of Oxford Divisions, serves residents and businesses of southeastern Pennsylvania. NPB, which has 74 community office locations, is a locally managed community bank providing commercial banking products, primarily loans and deposits.

The Company’s investment management units consist of National Penn Investors Trust Company (NPITC), which provides trust and investment management services; National Penn Investment Services, which markets brokerage services provided by PrimeVest Financial Services, Inc.; and National Penn Capital Advisors, Inc., which provides investment advisory services. The Company also provides mortgage banking activities through National Penn Mortgage Company (NPMC); insurance services through National Penn Insurance Agency, Inc.; and equipment leasing services through National Penn Leasing Company (NP Leasing).

The Company and its operating subsidiaries encounter vigorous competition for market share in the communities they serve from bank holding companies, other community banks, thrift institutions and other non-bank financial organizations, such as mutual fund companies, insurance companies and brokerage companies.

The Company and its operating subsidiaries are subject to regulations of certain state and federal agencies. These regulatory agencies periodically examine the Company and its subsidiaries for adherence to laws and regulations. As a consequence, the cost of doing business may be affected.

BASIS OF FINANCIAL STATEMENT PRESENTATION

The accounting policies followed by the Company conform with accounting principles generally accepted in the United States of America (“GAAP”) and predominant practice within the banking industry.

The consolidated financial statements include the accounts of the Company and the Company’s wholly owned subsidiaries, NPB, National Penn Investment Company, National Penn Life Insurance Company, and NPB’s wholly owned subsidiaries, NPITC, NPMC, NP Leasing, Link Financial Services, Inc., NPB Delaware, Inc., National Penn Capital Advisors, Inc., National Penn Insurance Agency, Inc., NPB Realty, Inc., Peoples First Business Investment Company, LLC, and National Penn Management Services, LLC. The Company’s investments in unconsolidated subsidiaries that range between 20% and 50% are accounted for using the equity method of accounting. All material inter-company balances have been eliminated.

In preparing the financial statements, management is required to make estimates and assumptions that affect the reported amounts of assets and liabilities, the disclosure of contingent assets and liabilities at the date of the balancesheets, and the reported amounts of revenues and expenses during the reporting period. Actual results could differ from those estimates.

The principal estimates that are susceptible to significant change in the near term relate to the allowance for loan losses and certain intangible assets, such as goodwill and core deposits.

Net income for year ended December 31, 2005 included a recovery of $2.28 million, net of taxes of approximately $1.2 million, on the 2004 fraud loss. The recovery was reduced by expenses of $1.2 million, net of taxes of approximately $671,000, for legal, auditing and other investigation-related services, for an impact from the fraud of $1.1 million, net of taxes of approximately $561,000, on 2005 net income. Net income for December 31, 2004 included a special charge of $6.7 million for losses attributable to the fraudulent loan and deposit scheme discovered by National Penn on January 5, 2005.

58

NATIONAL PENN BANCSHARES, INC. AND SUBSIDIARIES

Notes to Consolidated Financial Statements

December 31, 2005 and 2004

1.SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES - Continued

RECLASSIFICATIONS

Certain categories within the non-interest income section of the consolidated statements of income were classified for the year ended December 31, 2005 to reflect the changes made by the Company to the wealth management division. 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 for the years ended December 31, 2004 and 2003 were appropriately reclassified.

In 2005, the Company separately disclosed the operating, investing, and financing portions of cash flows attributable to discontinued operations occurring in 2003, which in prior periods were reported on a combined basis as a single amount in the consolidated statements of cash flows.

SIGNIFICANT GROUP CONCENTRATIONS OF CREDIT RISK

Most of the Company’s activities are with customers located throughout southeastern Pennsylvania. The Company’s commercial portfolio has a concentration in loans to commercial real estate investors and developers. 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.

INVESTMENT SECURITIES

Investment securities which are held for indefinite periods of time, which management intends to use as part of its asset/liability strategy, or which may be sold in response to changes in interest rates, changes in prepayment risk, increases in capital requirements, or other similar factors, are classified as available for sale and are carried at fair value. Net unrealized gains and losses for such securities, net of tax, are required to be recognized as a separate component of shareholders’ equity and excluded from determination of net income. Gains or losses on disposition are based on the net proceeds and cost of the securities sold, adjusted for amortization of premiums and accretion of discounts, using the specific identification method.

Certain investment securities are classified as held-to-maturity. The Company has the positive intent and ability to hold these securities to maturity. Held-to-maturity securities are classified at amortized cost.

59

NATIONAL PENN BANCSHARES, INC. AND SUBSIDIARIES

Notes to Consolidated Financial Statements - Continued

December 31, 2005 and 2004

1.SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES - Continued

In November 2005, the FASB issued FSP SFAS 115-1 and 124-1, “The Meaning of Other-Than- Temporary Impairment and Its Application to Certain Investments.” This FSP nullifies certain requirements of EITF 03-1 on this topic and provides additional guidance on when an investment in a debt or equity security should be considered impaired and when that impairment should be considered other-than-temporary and recognized as a loss in earnings. Specifically, the guidance clarifies that an investor should recognize an impairment loss no later than when the impairment is deemed other-than-temporary, even if a decision to sell has not been made. The FSP also required certain disclosures about unrealized losses that have not been recognized as other-than-temporary impairments. The amount of any other-than-temporary impairment that needs to be recognized will continue to be dependent on market conditions, the occurrence of certain events or changes in circumstances relative to an investee and an entity’s intent and ability to hold the impaired investment at the time of the valuation. FSP SFAS 115-1 and 124-1 was effective for reporting periods beginning after December 15, 2005. Adoption of this FSP did not have a material impact on the Company’s financial position or results of operations in 2005.

In 2004, NPB securitized approximately $41.8 million of one-to-four family residential mortgage loans in a guaranteed mortgage securitization with the Federal National Mortgage Association. NPB recognized no gain or loss on the transaction as it retained all of the resulting securities. NPB sold the servicing on all of the loans securitized. All of the resulting securities were classified as investment securities available for sale. There were no residential mortgage securitizations in 2005.

LOANS AND ALLOWANCE FOR LOAN AND LEASE LOSSES

Loans that management has the intent and ability to hold for the foreseeable future or until maturity or payoff are stated at the amount of unpaid principal, reduced by unearned income and an allowance for loan losses. Interest on loans is calculated based upon the principal amount outstanding. Accrual of interest is stopped on a loan when management believes, after considering economic and business conditions and collection efforts that the borrower’s financial condition is such that collection of interest is doubtful. The Company defers and amortizes certain origination and commitment fees, and certain direct loan origination costs over the contractual life of the related loans. This results in an adjustment of the related loan’s yield.

The allowance for loan losses is established through a provision for loan losses charged as an expense. Loans are charged against the allowance for loan losses when management believes that the collectibility of the principal is unlikely. The allowance is an amount that management believes will be adequate to absorb probable losses on existing loans that may become uncollectible based on evaluations of the collectibility of loans, and prior loan loss experience. The evaluation of the adequacy of the allowance for loan and lease losses includes an analysis of the individual loans and overall risk characteristics and size of the different loan portfolios, and takes into consideration current economic and market conditions, the capability of specific borrowers to pay specific loan obligations, as well as current loan collateral values. However, actual losses on specific loans, which also are encompassed in the analysis, may vary from estimated losses.

Loans originated and intended for sale in the secondary market are carried at the lower of cost or estimated fair value in the aggregate. Net unrealized losses, if any, are recognized through a valuation allowance by charges to income. Servicing is not retained on residential mortgage sales or securitizations. At December 31, 2005 and December 31, 2004, cost approximated fair value.

The Company accounts for its impaired loans in accordance with Statement of Financial Accounting Standards (SFAS) No. 114, Accounting by Creditors for Impairment of a Loan, as amended by SFAS No. 118, Accounting by Creditors for Impairment of a Loan - Income Recognition and Disclosures. This standard requires that a creditor measure impairment based on the present value of expected future cash flows discounted at the loan’s effective interest rate, except that as a practical expedient, a creditor may measure impairment based on a loan’s observable market price, or the fair value of the collateral if the loan is collateral dependent. Regardless of the measurement method, a creditor must measure impairment based on the fair value of the collateral when the creditor determines that foreclosure is probable. SFAS No. 114 excludes such homogeneous loans as consumer and mortgage.

60

NATIONAL PENN BANCSHARES, INC. AND SUBSIDIARIES

Notes to Consolidated Financial Statements - Continued

December 31, 2005 and 2004

1.SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES - Continued

The Company accounts for its transfers and servicing financial assets in accordance with SFAS No. 140, Accounting for Transfers and Servicing of Financial Assets and Extinguishments of Liabilities. SFAS No. 140 revises the standards for accounting for the securitizations and other transfers of financial assets and collateral.

In October 2003, the AICPA issued SOP 03-3 Accounting for Loans or Certain Debt Securities Acquired in a Transfer. SOP 03-3 applies to a loan with the evidence of deterioration of credit quality since origination acquired by completion of a transfer for which it is probable at acquisition, that the Company will be unable to collect all contractually required payments receivable. SOP 03-3 requires that the Company recognize the excess of all cash flows expected at acquisition over the investor’s initial investment in the loan as interest income on a level-yield basis over the life of the loan as the accretable yield. The loan’s contractual required payments receivable in excess of the amount of its cash flows excepted at acquisition (nonaccretable difference) should not be recognized as an adjustment to yield, a loss accrual or a valuation allowance for credit risk. SOP 03-3 was effective for loans acquired in fiscal years beginning after December 31, 2004 and was adopted by the Company on January 1, 2005. The adoption of this statement did not have a material effect on the Company’s financial position or results of operations in 2005. The Company will evaluate the assets acquired in the acquisition of Nittany Financial Corp. for applicability to this statement.

PREMISES AND EQUIPMENT

Buildings, equipment and leasehold improvements are stated at cost less accumulated depreciation and amortization computed by the straight-line method over the estimated useful lives of the assets.

GOODWILL AND OTHER INTANGIBLE ASSETS

The Company has recognized core deposit intangibles, as a result of branch acquisitions. Core deposit intangibles are amortized over estimated lives of deposit accounts. However, decreases in deposit lives may result in increased amortization and/or a charge for impairment may be recognized. Core deposit and other intangibles of $16,087,000 and $18,462,000, net of accumulated amortization at December 31, 2005 and 2004, respectively, are being amortized over an average of nine years. Amortization expense for core deposit and other intangibles for the year ended December 31, 2005, 2004 and 2003 was $2,355,000, $1,903,000, and $1,022,000, respectively.

Substantially all outstanding goodwill resulted from the acquisitions of Krombolz Insurance and Preferred Insurance Assoc. in 2005, Pennsurance, and D. E. Love Insurance, all divisions of National Penn Insurance, and Peoples First, Inc. in 2004 and FirstService Bank and Hometowne Heritage Bank in 2003, all divisions of National Penn Bank. The balance of goodwill at December 31, 2005 and 2004 was $187,995,000 and $186,945,000, respectively. The Company expanded its market role in Bucks, Chester and Lancaster Counties, Pennsylvania. However, if such benefits, including new business, are not derived, impairment may be recognized.

The Company is required to test goodwill and indefinite lived intangible assets for impairment rather than amortize them. The Company did not identify any impairment on its outstanding goodwill and its identifiable intangible assets from its most recent testing, performed at June 30, 2005.

61

NATIONAL PENN BANCSHARES, INC. AND SUBSIDIARIES

Notes to Consolidated Financial Statements - Continued

December 31, 2005 and 2004

1.SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES - Continued

OTHER ASSETS

Financing costs related to the issuance of junior subordinated debentures are being amortized over the life of the instruments and are included in other assets.

BANK OWNED LIFE INSURANCE

The Company invests 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 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 are all highly rated by A.M. Best and 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.

EMPLOYEE BENEFIT PLANS

The Company has certain employee benefit plans covering substantially all employees. Net pension expense consists of service cost, interest cost, return on pension assets and amortization of unrecognized initial net assets. The Company accrues pension costs as incurred.

STOCK-BASED COMPENSATION

The Company accounts for stock options under SFAS No. 123, Accounting for Stock-Based Compensation, as amended by SFAS No. 148, which contains a fair value-based method for 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 No. 25, Accounting for Stock Issued to Employees. Entities that continue to account for stock options using APB Opinion No. 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.

At December 31, 2005, the Company had a stock-based employee and director compensation plan, which is more fully described in Footnote 15. At December 31, 2005, the Company accounts for this plan and for its various predecessor plans under the recognition and measurement principles of APB No. 25, Accounting for Stock 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.

62

NATIONAL PENN BANCSHARES, INC. AND SUBSIDIARIES

Notes to Consolidated Financial Statements - Continued

December 31, 2005 and 2004

1. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES - Continued

		Year ended December 31,
		2005		2004		2003
Net income, as reported		$	59,755	$	47,914	$	43,354
Less: stock-based compensation costs
determined under fair value based
method for all awards			1,275		1,130		852
Net income, pro forma		$	58,480	$	46,784	$	42,502
Earnings per share of common stock - basic	As reported	$	1.38	$	1.17	$	1.17
	Pro forma		1.35		1.15		1.14
Earnings per share of common stock - diluted	As reported		1.36		1.15		1.14
	Pro forma		1.33		1.12		1.11

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, 2004, and 2003, respectively: dividend yield of 3.47%, 3.19%, and 3.03%, expected volatility of 28.58%, 26.08%, and 27.89%; risk-free interest rates of 4.58%, 4.17% and 4.03%; and expected lives of 7.61 years, 6.48 years, and 6.02 years.

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 SFAS123R for public companies by issuing Release 33-8568. The new rule allows registrants to implement SFAS123R at the beginning of their next fiscal year, instead of the next interim period, that began after June 15, 2005. SFAS123R will therefore be effective for the Company beginning the first quarter of 2006. For the transition to SFAS123R, the Company anticipates utilizing the modified retrospective application to periods before the required effective date. Under this method of adoption, the Company will adjust its prior financial statements consistent with the amounts shown using the fair-value based method of accounting included in the pro forma disclosures in this Footnote. The Company also anticipates that it will continue utilizing the Black-Scholes option pricing model for valuing future stock option grants and anticipates annual future impact on the Company to be similar to the amounts disclosed in this Footnote.

INCOME TAXES

The Company accounts for income taxes under the liability method of accounting for income taxes. Deferred tax assets and liabilities are determined based on the difference between the financial statement and tax bases of assets and liabilities as measured by the enacted tax rates that will be in effect when these differences reverse.

63

NATIONAL PENN BANCSHARES, INC. AND SUBSIDIARIES

Notes to Consolidated Financial Statements - Continued

December 31, 2005 and 2004

1.SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES - Continued

Deferred tax expense is the result of changes in deferred tax assets and liabilities. The principal types of differences between assets and liabilities for financial statement and tax return purposes are allowance for loan losses, deferred loan fees, deferred compensation and investment securities available for sale.

STATEMENTS OF CASH FLOWS

The Company considers cash and due from banks, interest bearing deposits in banks and federal funds sold as cash equivalents for the purposes of reporting cash flows. Cash paid for interest and taxes is as follows (in thousands):

	Year ended December 31,
	2005		2004		2003
Interest	$	86,531	$	58,518	$	50,525
Taxes		17,764		13,795		9,999

OTHER REAL ESTATE OWNED

Other real estate owned is recorded at the lower of cost or estimated fair market value less costs of disposal. When property is acquired, the excess, if any, of the loan balance over fair market value is charged to the allowance for possible loan losses. Periodically thereafter, the asset is reviewed for subsequent declines in the estimated fair market value. Subsequent declines, if any, and holding costs, as well as gains and losses on subsequent sale, are included in the consolidated statements of income.

EARNINGS PER SHARE

Earnings per share is calculated on the basis of the weighted average number of common shares outstanding during the year. All per share information in the financial statements has been adjusted retroactively for the effect of stock dividends and splits.

Basic earnings per share excludes dilution and is computed by dividing income available to common shareholders by the weighted average common shares outstanding during the period. Diluted earnings per share takes into account the potential dilution that could occur if securities or other contracts to issue common stock were exercised and converted into common stock.

ADVERTISING COSTS

It is the Company’s policy to expense advertising costs in the period in which they are incurred.

DERIVATIVES

Financial derivatives are reported at fair value in other assets or other liabilities. The accounting for changes in the fair value of a derivative instrument depends on whether it has been designated and qualifies as part of a hedging relationship. For derivatives not designated as hedges, the gain or loss is recognized in current earnings.

64

NATIONAL PENN BANCSHARES, INC. AND SUBSIDIARIES

Notes to Consolidated Financial Statements - Continued

December 31, 2005 and 2004

1. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES - Continued

The Company has entered into interest rate swap contracts to modify the interest rate characteristics from variable to fixed in order to reduce the impact of interest rate changes on future interest expense. Net amounts payable or receivable from this contract are accrued as an adjustment to interest expense. The fair value of these derivatives is reported in other assets or other liabilities and offset in accumulated other comprehensive income for the effective portion of the derivatives. Amounts reclassified into earnings, when the hedged transaction culminates, are included in interest expense. Ineffectiveness of the strategy, as defined under SFAS No. 133, if any, is reported in interest expense. The Company performs an assessment, both at the inception of the hedge and quarterly thereafter, to determine whether these derivatives are highly effective in offsetting changes in the value of the hedged items. All of the Company’s interest rate swap contracts matured in December 2004. The Company had no interest rate swap contracts in 2005.

The Company periodically enters into commitments with its customers for loans which it intends to sell in the future. At December 31, 2005, such commitments with a notional amount of approximately $20.0 million were outstanding. The Company’s methodology for valuing these unfunded commitments is to determine a potential gain or loss by assuming all commitments were actually funded and sold on the secondary market on December 31, 2005.

On March 9, 2004, the Securities and Exchange Commission staff released Staff Accounting Bulletin (SAB) 105, “Loan Commitments Accounted for as Derivative Instruments.” SAB 105 requires that a lender not consider the expected future cash flows related to loan servicing or include internally developed intangible assets, such as customer-related intangible assets, in determining the fair value of loan commitments accounted for as derivatives.

VARIABLE INTEREST ENTITIES

Management determined that NPB Capital Trust II, III, IV (collectively, the Trusts) qualified as a variable interest entity under FIN 46, as revised. The Company adopted the provisions under the revised interpretation in the first quarter of 2004. Accordingly, the Company de-consolidated the Trusts. FIN 46(R) precludes consideration of the call option embedded in the preferred capital securities when determining if the Company has the right to a majority of NPB Capital Trust II’s expected residual returns. The de-consolidation resulted in the investment in the common capital securities of NPB Capital Trust II being included in unconsolidated investments under the equity method as of March 31, 2004 with a corresponding increase in outstanding debt of $2.0 million. In addition, the income received on the Company’s common capital securities investment is included in equity in earnings of unconsolidated subsidiaries. The adoption of FIN 46(R) did not have a material impact on the financial position or results of operations.

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.

65

NATIONAL PENN BANCSHARES, INC. AND SUBSIDIARIES

Notes to Consolidated Financial Statements - Continued

December 31, 2005 and 2004

1.SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES - Continued 

COMPREHENSIVE INCOME

SFAS No. 130, Reporting Comprehensive Income, requires the reporting of comprehensive income, which includes net income as well as certain other items, which results in a change to equity during the period (in thousands).

	December 31, 2005									December 31, 2004									December 31, 2003
	Before Tax Amount			Tax (expense) Benefit			Net of Tax Amount			Before Tax Amount			Tax (expense) Benefit			Net of Tax Amount			Before Tax Amount			Tax (expense) Benefit			Net of Tax Amount
Unrealized gains (losses)
on investment securities
Unrealized holding gains loss) arising during period	$	(25,177	)	$	8,812		$	(16,369	)	$	1,205		$	(143	)	$	1,062		$	3,589		$	(1,568	)	$	2,021
Less reclassification adjustment for gains
(losses) realized in net
income		555			(194	)		361			(84	)		29			(55	)		(369	)		129			(240	)
Unrealized gains (losses)
on investment securities		(25,732	)		9,006			(16,726	)		1,289			(172	)		1,117			3,958			(1,697	)		2,261
Change in fair value of
cash flow hedges		-			-			-			(797	)		-			(797	)		(1,962	)		-			(1,962	)
Other comprehensive
income (loss), net	$	(25,732	)	$	9,006		$	(16,726	)	$	492		$	(172	)	$	320		$	1,996		$	(1,697	)	$	299

66

NATIONAL PENN BANCSHARES, INC. AND SUBSIDIARIES

Notes to Consolidated Financial Statements - Continued

December 31, 2005 and 2004

2.ACQUISITIONS AND DISPOSITIONS

Acquisition of Nittany Financial Corp.

On January 26, 2006, the Company completed the acquisition of Nittany Financial Corp. (“Nittany”) parent company of Nittany Bank. Under the terms of the merger agreement, 2,270,442 shares of Nittany common stock were each exchanged for 1.994 shares of National Penn common stock, $42.43 in cash, or a combination of both, resulting in the issuance of 3,169,083 shares of National Penn common stock and payment of approximately $28.9 million in cash. The total purchase price (cash and stock) was valued at $96.0 million. In addition, 40,684 outstanding stock options to purchase shares of Nittany common stock were converted into options to purchase 81,537 shares of National Penn common stock, with an exercise price ranging from $2.86 to $10.39 per share.

The acquisition resulted in the recording of approximately $75 million of goodwill and $5.3 million of other intangible assets. The Company acquired assets, loans and deposits of $323.1 million, $279.4 million, and

$249.7 million, respectively.

State College, Pennsylvania-based Nittany Bank operated four offices in State College and one office in Bellefonte, Pennsylvania, at the time of acquisition. Nittany Bank will initially operate as a wholly owned subsidiary of National Penn.

Nittany also owns two investment subsidiaries; Nittany Asset Management, Inc., which offers retail investment products through the Bank’s five offices; and Vantage Investment Advisors, LLC, which is a registered investment advisory firm providing fee-based investment management services. Vantage manages investments for small business retirement plans as well as provides individual portfolio management for consumers.

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. These agencies operate as divisions of National Penn Bank's insurance agency subsidiary, National Penn Insurance Agency, Inc. On December 1, 2005, the Company acquired the insurance agency business of Preferred Risk Associates. The four transactions resulted in the issuance of 25,070 shares of the Company's common stock and cash payments totaling $3.96 million. The acquisitions resulted in the recording of approximately $4.6 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.

67

NATIONAL PENN BANCSHARES, INC. AND SUBSIDIARIES

Notes to Consolidated Financial Statements - Continued

December 31, 2005 and 2004

2.ACQUISITIONS AND DISPOSITIONS - Continued

Acquisition of HomeTowne Heritage Bank

On December 12, 2003, the Company completed a merger with HomeTowne Heritage Bank (“HomeTowne”). Under the terms of the merger, each outstanding share of common stock of HomeTowne was exchanged for $13.697 in cash resulting in the payment of approximately $37.6 million. In addition, outstanding stock options to purchase 1,230,415 shares of HomeTowne common stock were converted into stock options to purchase 451,126 shares of the Company’s common stock, with an exercise price ranging between $7.74 and $15.49 per share. This transaction was accounted for under the purchase method of accounting. Accordingly, the results of operations of the Company include HomeTowne’s results from and after December 12, 2003. The acquisition resulted in the recording of approximately $23.3 million of goodwill and $2.3 million of other intangible assets. The Company acquired assets, loans and deposits of $165.8 million, $157.1 million, and $134.4 million, respectively.

Acquisition of FirstService Bank

On February 25, 2003, the Company completed a merger with FirstService Bank (“FirstService”). Under the terms of the merger, each outstanding share of FirstService common stock was converted into 0.5954 shares of the Company’s common stock plus $3.90, resulting in an issuance of 4,005,550 shares of the Company’s common stock and approximately $16.8 million in cash. In addition, outstanding stock options to purchase FirstService common stock were converted into stock options to purchase 1,004,951 shares of the Company’s common stock, with an exercise price of either $4.28 or $8.56 per share. This transaction was accounted for under the purchase method of accounting. Accordingly, the results of operations of the Company include FirstService’s results from and after February 25, 2003. The acquisition resulted in the recording of approximately $59.2 million of goodwill and $8.7 million of other intangibles. The company acquired assets, loans and deposits of $367.9 million, $223.1 million, and $289.4 million, respectively.

Disposition of Panasia Bank, N.A.

On September 11, 2003, the Company completed the cash sale of Panasia Bank N.A., a wholly owned subsidiary, for $34.5 million, which resulted in a gain of $6.68 million after taxes of $1.8 million. In accordance with SFAS No. 144, Accounting for the Impairment or Disposal of Long-Lived Assets, the income of Panasia is presented as discontinued operations for all periods presented. At the time of the sale, Panasia had total assets of $213.5 million, net loans of $99.7 million, investments of $84.4 million, deposits of $188.2 million, and total equity of $24.4 million. The Company has classified the results of operations of Panasia from January 1, 2003 through September 11, 2003 as discontinued operations in the consolidated statement of income. Net income from discontinued operations, net of taxes of $2.7 million for the year ended December 31, 2003 was $8.6 million.

68

NATIONAL PENN BANCSHARES, INC. AND SUBSIDIARIES

Notes to Consolidated Financial Statements - Continued

December 31, 2005 and 2004

The following represents the per share amounts for continuing and discontinued operations for the years ended December 31, 2005, 2004 and 2003:

	Year ended December 31,
	2005		2004		2003
Net income per share - basic
Continuing operations	$	1.38	$	1.17	$	.93
Discontinued operations		-		-		.24
Net Income per share - basic	$	1.38	$	1.17	$	1.17
Net income per share - diluted
Continuing operations	$	1.36	$	1.15	$	.91
Discontinued operations		-		-		.23
Net income per share - diluted	$	1.36	$	1.15	$	1.14

3. INVESTMENT SECURITIES

The amortized cost, gross unrealized gains and losses, and fair values of the Company’s investment securities are summarized as follows (in thousands):

	December 31, 2005
	Amortized		Gross unrealized		Gross unrealized			Fair
	cost		gains		losses			value
Available for Sale
U.S. Treasury and U.S. Government agencies	$	178,412	$	1,308	$	(4,070	)	$	175,650
State and municipal bonds		232,738		10,712		(161	)		243,289
Mortgage-backed securities		468,758		866		(11,158	)		458,460
Marketable equity securities and other		56,298		8,432		(1,023	)		63,707
Totals - Investments Available for Sale	$	936,206	$	21,318	$	(16,412	)	$	941,106
Held to Maturity
Mortgage-backed securities	$	79,212	$	-	$	(2,404	)	$	76,808
State & municipal bonds		71,396		26		(602	)		70,820
Totals - Investments Held to Maturity	$	150,608	$	26	$	(3,006	)	$	147,628
	December 31, 2004
		Amortized		Gross unrealized		Gross unrealized			Fair
		cost		gains		losses			value
Available for Sale
U.S. Treasury and U.S. Government agencies	$	219,285	$	2,837	$	(1,378	)	$	220,744
State and municipal bonds		261,906		17,767		(108	)		279,565
Mortgage-backed securities		529,033		3,591		(2,403	)		530,221
Marketable equity securities and other		57,974		10,981		(649	)		68,306
Totals - Investments Available for Sale	$	1,068,198	$	35,176	$	(4,538	)	$	1,098,836

Held to Maturity
Mortgage-backed securities	$	90,967		-	$	(346	)	$	90,621
Totals - Investments Held to Maturity	$	90,967	$	-	$	(346	)	$	90,621

69

NATIONAL PENN BANCSHARES, INC. AND SUBSIDIARIES

Notes to Consolidated Financial Statements - Continued

December 31, 2005 and 2004

3. INVESTMENT SECURITIES - Continued

The amortized cost and fair value of investment securities, by contractual maturity, at December 31, 2005 (in thousands), are shown below. Expected maturities will differ from contractual maturities because borrowers may have the right to call or prepay obligations with or without call or prepayment penalties.

	Available for Sale				Held to Maturity
	Amortized		Fair		Amortized		Fair
	cost		value		cost		value
Due in one year or less	$	17,765	$	17,847	$	-	$	-
Due after one through five years		326,566		320,988		-		-
Due after five through ten years		163,702		161,451		79,212		76,808
Due after ten years		371,875		377,113		71,396		70,820
Marketable equity securities and other		56,298		63,707		-		-
	$	936,206	$	941,106	$	150,608	$	147,628

Proceeds from the sales of investment securities during 2005, 2004 and 2003, were $45,748,000, $56,299,000, and $34,663,000, respectively. Gross gains realized on those sales were $1,266,000, $645,000, and $0, in 2005, 2004 and 2003, respectively. Gross losses were $711,000 in 2005, $196,000 in 2004, and $369,000 in 2003. As of December 31, 2005 and 2004, investment securities with a fair value of $1.0 billion and $1.0 billion, respectively, were pledged to secure public deposits and for other purposes as provided by law. As of December 31, 2005 and 2004, the Company did not have any investment securities of any one issuer where the carrying value exceeded 10% of shareholders’ equity.

The table below indicates the length of time individual securities have been in a continuous unrealized loss position at December 31, 2005:

			Less than 12 months					12 months or longer					Total
	Number of Securities		Fair Value		Unrealized Losses			Fair Value		Unrealized Losses			Fair Value		Unrealized Losses
U.S. Treasury and U.S.
Government Agencies		39	$	36,463	$	(728	)	$	105,223	$	(3,342	)	$	141,686	$	(4,070	)
State and municipal bonds		119		63,713		(651	)		482		(113	)		64,195		(763	)
Mortgage-backed securities		114		179,149		(3,155	)		294,687		(10,407	)		473,836		(13,562	)
Other bonds		5		491		(10	)		1,613		(42	)		2,104		(52	)
Total debt securities		277		279,816		(4,544	)		402,005		(13,904	)		681,821		(18,447	)
Marketable equity securities		6		4,299		(938	)		1,465		(32	)		5,764		(971	)
Total securities		283	$	284,115	$	(5,482	)	$	403,470	$	(13,936	)	$	687,585	$	(19,418	)

At December 31, 2005, 95% of the unrealized losses in the available-for-sale security portfolio were comprised of securities issued by the U.S. Treasury and Government agencies, U.S. Government sponsored agencies and agency mortgage-backed securities. The Company believes the price movements in these securities are dependent upon movements in market interest rates, particularly given the negligible inherent credit risk for these securities.

70

NATIONAL PENN BANCSHARES, INC. AND SUBSIDIARIES

Notes to Consolidated Financial Statements - Continued

December 31, 2005 and 2004

The table below indicates the length of time individual securities have been in a continuous unrealized loss position at December 31, 2004:

			Less than 12 months					12 months or longer					Total
	Number of Securities		Fair Value		Unrealized Losses			Fair Value		Unrealized Losses			Fair Value		Unrealized Losses
U.S. Treasury and U.S.
Government Agencies		44	$	126,857	$	(1,205	)	$	10,827	$	(173	)	$	137,684	$	(1,378	)
State and municipal bonds		4		488		(108	)		-		-			488		(108	)
Mortgage-backed securities		66		256,666		(1,546	)		112,389		(1,203	)		369,055		(2,749	)
Other bonds		3		1,756		(20	)		-		-			1,756		(20	)
Total debt securities		117		385,767		(2,879	)		123,216		(1,376	)		508,983		(4,255	)
Marketable equity securities		9		949		(50	)		8,220		(579	)		9,169		(629	)
Total securities		126	$	386,716	$	(2,929	)	$	131,436	$	(1,955	)	$	518,152	$	(4,884	)

The unrealized losses are due to changes in market value stemming from changes in the general level of interest rates and is considered to be temporary.

4. LOANS

Major classifications of loans, including $9.1 million and $9.8 million in unearned income in 2005 and 2004, respectively, are as follows (in thousands) (1):

	December 31,
	2005			2004
Commercial and industrial loans and leases	$	708,653		$	625,554
Real estate loans
Construction and land development		206,201			201,410
Residential, including $18,583 and $11,801 in loans held for sale		1,078,772			1,025,955
Other (non-farm, non-residential real estate)		995,596			957,677
Loans to individuals		60,586			63,843
		3,049,808			2,874,439
Allowance for loan and lease losses		(56,064	)		(57,590	)
Total loans, net	$	2,993,744		$	2,816,849

(1) The classification of loans in the above table corresponds to defined bank regulatory reporting categories and is presented for analytical purposes.

Loans on which the accrual of interest has been discontinued or reduced amounted to approximately $11,961,000 and $11,103,000 at December 31, 2005 and 2004, respectively. The gross amount of interest that would have been recorded on these loans would have been approximately $878,000, and $492,000, respectively. Interest on these loans in 2003 would have been approximately $449,000. If interest on these loans had been accrued net of cash payments received, interest income would have increased by approximately $437,000 for 2005 and decreased $343,000 for 2004, as interest collected in these periods was accrued in prior years. Interest income would have decreased $164,000 for 2003 if interest on these loans had been accrued. Loan balances past due 90 days or more and still accruing interest, but which management expects will eventually be paid in full, amounted to $183,000 and $870,000 at December 31, 2005 and 2004, respectively.

71

NATIONAL PENN BANCSHARES, INC. AND SUBSIDIARIES

Notes to Consolidated Financial Statements - Continued

December 31, 2005 and 2004

4.LOANS - Continued

The balance of impaired loans was $11,961,000 at December 31, 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. The total of impaired loans with and without a valuation allowance at December 31, 2005 was $3,468,000 and $8,493,000, respectively. The valuation allowance related to impaired loans December 31, 2005 was $1,716,000. The average balance of impaired loans was $12,237,507 during 2005 and the income recognized on impaired loans during 2005 was $405,000. 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.

The balance of impaired loans was $11,103,000 at December 31, 2004. The allowance for loan loss associated with the $11,103,000 of impaired loans was $86,000 at December 31, 2004. The average impaired loan balance was $11,620,000 during 2004, and the income recognized on impaired loans during 2004 was $731,000.

The balance of impaired loans was $10,707,000 at December 31, 2003. The allowance for loan loss associated with the $10,707,000 of impaired loans was $971,000 at December 31, 2003. The average impaired loan balance was $13,589,000 during 2003 and the income recognized on impaired loans during 2003 was $452,000.

Changes in the allowance for loan and lease losses are as follows (in thousands):

	Year ended December 31,
	2005			2004			2003
Balance, beginning of year	$	57,590		$	49,265		$	40,578
Provision charged to operations		3,200			4,800			9,371
Loans charged off		(7,245	)		(5,617	)		(12,344	)
Recoveries		2,519			2,978			5,497
Acquisition of FirstService and HomeTowne		-			-			6,163
Acquisition of Peoples First		-			6,164			-
Balance, end of year	$	56,064		$	57,590		$	49,265

72

NATIONAL PENN BANCSHARES, INC. AND SUBSIDIARIES

Notes to Consolidated Financial Statements - Continued

December 31, 2005 and 2004

5. PREMISES AND EQUIPMENT

Major classifications of premises and equipment are summarized as follows (in thousands):

	Estimated		Year ended December 31,
	useful lives		2005			2004
Land		Indefinite	$	8,358		$	6,855
Buildings		5 to 40 years		46,403			46,101
Equipment		3 to 10 years		52,579			50,650
Leasehold improvements		2 to 10 years		6,707			6,482
				114,047			110,088
Accumulated depreciation and amortization				(60,889	)		(56,369	)
			$	53,158		$	53,719

Depreciation and amortization expense amounted to $6,862,000, $5,247,000, and $5,249,000 for the years ended December 31, 2005, 2004 and 2003, respectively.

6. DEPOSITS

The aggregate amount of jumbo certificates of deposit, each with a minimum denomination of $100,000, was approximately $480,975,000 and $246,948,000 in 2005 and 2004, respectively.

At December 31, 2005, the scheduled maturities of certificates of deposit are as follows (in thousands):

2006	$	790,144
2007		322,647
2008		85,400
2009		37,546
2010		19,342
Thereafter		2,690
	$	1,257,769

73

NATIONAL PENN BANCSHARES, INC. AND SUBSIDIARIES

Notes to Consolidated Financial Statements - Continued

December 31, 2005 and 2004

7.SHORT-TERM BORROWINGS

Federal funds purchased and securities sold under agreements to repurchase generally mature within 30 days from the date of the transactions. Short-term borrowings consist of Treasury Tax and Loan Note Options and various other borrowings, which generally have maturities of less than one year. The details of these categories are presented below (dollars in thousands):

	At or for the year ended December 31,
	2005			2004			2003
Securities sold under repurchase agreements and
federal funds purchased
Balance at year-end	$	419,976		$	504,051		$	500,038
Average during the year		553,872			501,781			324,492
Maximum month-end balance		736,892			635,067			500,038
Weighted average rate during the year		2.44	%		1.24	%		1.22	%
Rate at December 31		2.63	%		1.79	%		1.08	%
Short-term borrowings
Balance at year-end	$	8,795		$	10,000		$	10,000
Average during the year		4,936			5,077			5,179
Maximum month-end balance		10,000			10,093			10,045
Weighted average rate during the year		2.88	%		1.08	%		.77	%
Rate at December 31		4.00	%		1.87	%		.59	%

The weighted average rates paid in aggregate on these borrowed funds for 2005, 2004, and 2003 were 2.44%, 1.24%, and 1.21%, respectively.

8.LONG-TERM BORROWINGS

FHLB ADVANCES

At December 31, 2005 and 2004, advances from the Federal Home Loan Bank (FHLB) totaling $248.4 million and $229.9 million will mature within one to fourteen years and are reported as long-term borrowings. The advances are collateralized by FHLB stock and certain first mortgage loans and mortgage-backed securities. These advances had a weighted average interest rate of 4.09% and 4.26% at December 31, 2005 and 2004, respectively. Unused lines of credit at the FHLB were $594,978,000 and $452,853,000 at December 31, 2005 and 2004, respectively.

Outstanding borrowings mature as follows (in thousands):

2006	$36,586
2007	42,500
2008	32,000
2009	37,411
2010	4,976
Thereafter	94,939
	$248,412

74

NATIONAL PENN BANCSHARES, INC. AND SUBSIDIARIES

Notes to Consolidated Financial Statements - Continued

December 31, 2005 and 2004

8.LONG-TERM BORROWINGS - Continued

In December 2005, the Company completed a refinance of approximately $55.7 million of long-term debt with the Federal Home Loan Bank of Pittsburgh with a weighted average rate of 6.09% and a weighted average remaining life of approximately 50 months. The Company paid a prepayment fee of $45,600 before taxes and included the prepayment fee in other expenses. The Company obtained new debt of $56.0 million, which has a weighted average interest rate of 5.36% and a weighted average life of approximately 116 months.

In 2003, the Company paid a prepayment fee of $7.0 million before taxes on a refinance of approximately $77.5 million of long-term debt with the Federal Home Loan Bank of Pittsburgh. This fee is included in other expenses for the year ended December 31, 2003.

SUBORDINATED DEBENTURES

As of December 31, 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 $65.206 million of debentures issued to NPB Capital Trust II on August 20, 2002 mature on September 30, 2032, and bear interest at the annual fixed rate of 7.85%.

 · The $20.619 million of debentures issued to NPB Capital Trust III on 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 $20.619 million of debentures issued to NPB Capital Trust IV on 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 $20.619 million of debentures issued to NPB Capital Trust V on April 7, 2004 mature on April 7, 2034, and bear interest at a floating rate (three month LIBOR plus a margin of 2.75%).

As of January 19, 2006, the Company established an additional statutory business trust, NPB Capital Trust VI. The Company owns all the common capital securities of this trust. This trust also 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 trust. The $15.464 million of debentures issued to NPB Capital Trust VI on January 19, 2006 mature on March 15, 2036 and bear interest at a floating rate (three month LIBOR plus a margin of 1.38%).

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.

75

NATIONAL PENN BANCSHARES, INC. AND SUBSIDIARIES

Notes to Consolidated Financial Statements - Continued

December 31, 2005 and 2004

9. BENEFIT PLANS

PENSION PLAN

The Company has a non-contributory defined benefit pension plan covering, as of December 31, 2005, substantially all employees of the Company and its subsidiaries other than National Penn Mortgage Company. The Company-sponsored pension plan provides retirement benefits under pension trust agreements. The benefits are based on years of service and the employee’s compensation during the highest five consecutive years during the last ten consecutive years of employment. The Company’s policy is to fund pension costs allowable for income tax purposes.

The following table sets forth the plan’s funded status and amounts recognized in the Company’s consolidated balance sheets (in thousands):

	December 31,
	2005			2004
Change in benefit obligation
Benefit obligation at beginning of year	$	24,555		$	20,384
Service cost		2,123			1,572
Interest cost		1,458			1,266
Actual gain		1,842			709
Benefits paid		(612	)		(451	)
Effect of change in assumptions		1,660			1,075
Benefit obligations at end of year		31,026			24,555
Change in plan assets
Fair value of plan assets at beginning of year		21,223			18,908
Actual return on plan assets		2,061			1,437
Employer contribution		1,813			1,329
Benefits paid		(612	)		(451	)
Fair value of plan assets at end of year		24,485			21,223
Funded status		(6,541	)		(3,332	)
Unrecognized net actuarial gain		8,088			5,133
Unrecognized prior service cost		49			44
Prepaid benefit cost (included in other assets)	$	1,596		$	1,845

The accumulated benefit obligation was $22,914,000 and $17,978,000 at December 31, 2005 and 2004, respectively.

76

NATIONAL PENN BANCSHARES, INC. AND SUBSIDIARIES

Notes to Consolidated Financial Statements - Continued

December 31, 2005 and 2004

9. BENEFIT PLANS - Continued

Net pension cost included the following components (in thousands):

	Year ended December 31,
	2005			2004			2003
Service cost	$	2,123		$	1,572		$	1,264
Interest cost on projected benefit obligation		1,458			1,266			1,069
Return on plan assets (1)		(1,737	)		(1,437	)		(2,492	)
Net amortization and deferral		218			(28	)		1,324
Net periodic benefit cost	$	2,063		$	1,373		$	1,165
(1) Expected return is presented for 2005. Actual return is presented for 2004 and 2003.
Weighted-average assumptions used
to determine benefit obligations at December 31
		2005			2004
Discount rate		5.75	%		6.13	%
Rate of compensation increase		3.75	%		4.00	%
Weighted-average assumptions used
to determine net periodic benefit cost
for years ended December 31
		2005			2004
Discount rate		5.75	%		6.13	%
Expected long-term return on plan assets		8.25	%		8.25	%
Rate of compensation increase		3.75	%		4.00	%

Plan Assets

The Company’s pension plan weighted-average asset allocations at December 31, 2005, and 2004, by asset category are as follows:

	Plan Assets
	At December 31,
	2005	2004
Asset Category
Equity securities	57%	53%
Debt securities	37%	38%
Other	6%	9%
Total	100%	100%

The plan does not have any assets in the Company’s common stock.

77

NATIONAL PENN BANCSHARES, INC. AND SUBSIDIARIES

Notes to Consolidated Financial Statements - Continued

December 31, 2005 and 2004

9.BENEFIT PLANS - Continued

Estimated Future Benefit Payments

Estimated future benefit payments, which reflect expected future service, as appropriate, are as follows (in thousands):

2006	$	492
2007		618
2008		655
2009		840
2010		910
Years 2011-2015		8,025

Effective April 1, 2006, the Company amended the defined benefit pension plan to substitute a formula capping the maximum annual participating salary at $50,000 and extending plan eligibility to employees of National Penn Mortgage Company and newly-acquired Nittany Financial Corp. and its subsidiaries.

CAPITAL ACCUMULATION PLAN

The Company has a capital accumulation and salary reduction plan under Section 401(k) of the Internal Revenue Code of 1986, as amended. Under the plan as in effect at December 31, 2005, eligible participants may contribute a minimum of 1% of eligible earnings up to a maximum of the respective annual IRS allowable contribution each year. The Company matches 50% of the first 7% of each employee’s contribution. Matching contributions to the plan were $1.3 million, $1.1 million, and $965,000 for the years ended December 31, 2005, 2004 and 2003, respectively.

Effective April 1, 2006, the Company amended the plan to enable new employees to become eligible to participate on the first day of any month following 30 days employment and added a profit sharing contribution based on corporate earnings per share.

DEFERRED COMPENSATION ARRANGEMENTS

The Company has established deferred compensation arrangements for certain executive officers. The deferred compensation plans provide for annual payments for fifteen years following retirement. The Company’s liabilities under these arrangements are being accrued from the commencement of the plans over the participant’s remaining periods of service. The expense recorded in connection with these deferred compensation plans, which are unfunded, was $90,000, $120,000, and $320,000 for the years ended December 31, 2005, 2004 and 2003.

The Company, through its acquisitions of FirstService Bank, HomeTowne Heritage Bank, and Peoples First, Inc. has several non-qualified, unfunded Supplemental Executive Retirement Plans (SERPs) for certain officers. These SERPs supplement the benefit these executive officers will receive under the Company’s qualified retirement plans, and provide annual benefits up to 60% of the executives’ final compensation, as defined under the SERPs, payable over the executives’ remaining lifetime assuming the executive attains age 62. The SERPs also provide for survivor and certain other termination benefits. The expense recorded in connection with these SERPs was $640,000, $940,000 and $231,000 for the years ended December 31, 2005, 2004 and 2003, respectively. The Company is the beneficiary of life insurance policies with an aggregate cash surrender value of $17.8 million that are a method of funding benefits under these plans. The Company, through its acquisition of Nittany Financial Corp. on January 26, 2006, has SERPs for certain officers of Nittany Financial Corp. and its subsidiaries. The Company is the beneficiary of certain life insurance policies as a method of funding benefits under these plans.

78

NATIONAL PENN BANCSHARES, INC. AND SUBSIDIARIES

Notes to Consolidated Financial Statements - Continued

December 31, 2005 and 2004

10. INCOME TAXES

The components of the income tax expense included in the consolidated statements of income are as follows (in thousands):

	Year ended December 31,
	2005		2004			2003
Income tax expense
Current	$	16,122	$	14,564		$	5,104
Deferred federal (benefit) expense		2,256		(2,569	)		(503	)
		18,378		11,995			4,601
Additional paid-in capital from benefit
of stock options exercised		1,229		2,856			4,096
Applicable income tax expense	$	19,607	$	14,851		$	8,697

The differences between applicable income tax expense and the amount computed by applying the statutory federal income tax rate of 35% are as follows (in thousands):

	Year ended December 31,
	2005			2004			2003
Computed tax expense at statutory rate	$	27,769		$	21,968		$	15,201
Decrease in taxes resulting from:
Tax-exempt loan and investment income		(7,293	)		(6,891	)		(6,697	)
Tax credits		(682	)		(300	)		(300	)
Amortization of goodwill and intangibles		(149	)		(149	)		(149	)
Other, net		(38	)		223			642
Applicable income tax expense	$	19,607		$	14,851		$	8,697

Deferred tax assets and liabilities consist of the following (in thousands):

	2005		2004
Deferred tax assets
Allowance for loan and lease loss	$	17,983	$	18,924
Deferred compensation		3,891		3,484
Loan sales valuation		-		54
Special charge for fraud loss		1,050		2,339
		22,924		24,801
Deferred tax liabilities
Pension		1,436		1,281
Partnership investments		229		718
Depreciation		2,437		1,505
Investment securities available for sale		1,717		10,723
Rehab credit adjustment		44		44
Loan costs		2,218		1,748
Core deposit intangibles		5,271		5,960
		13,352		21,979
Net deferred tax asset (included in other assets)	$	9,572	$	2,822

79

NATIONAL PENN BANCSHARES, INC. AND SUBSIDIARIES

Notes to Consolidated Financial Statements - Continued

December 31, 2005 and 2004

10.INCOME TAXES - Continued

As a result of the acquisition of Peoples First, Inc., the Company acquired a net deferred tax liability of $1,202,000 in 2004, which includes $3,252,000 related to the recognition of the core deposit intangible and unrealized holding gains in 2004.

11. SHAREHOLDERS’ EQUITY

On December 21, 2005, the Company’s Board or Directors authorized the repurchase of up to 2 million shares of the Company’s common stock to be used to fund the Company’s dividend reinvestment plan, stock compensation plans, stock-based benefit plans, and employee stock purchase plan. No timetable was set for these repurchases, but none will be made until completion of the repurchase program approved in September 2003.

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 information 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 1.56 million 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 compensation plans, stock-based benefit plans, and employee stock purchase plan No timetable was set for these repurchases. As of December 31, 2005, 1,293,618 shares had been repurchased at an average price of $24.35 per share.

On August 27, 2003, the Company’s Board of Directors declared a 5% stock dividend to shareholders of record on September 12, 2003, which was paid on September 30, 2003.

12. SHAREHOLDER RIGHTS PLAN

The Company adopted a Shareholder Rights Plan (the Rights Plan) in 1989 to protect shareholders from attempts to acquire control of the Company at an inadequate price. Under the Rights Plan, the Company distributed a dividend of one right to purchase a unit of preferred stock on each outstanding common share of the Company. The rights are not currently exercisable or transferable, and no separate certificates evidencing such rights will be distributed, unless certain events occur. The rights were to expire on August 22, 1999. On August 21, 1999, the Plan was amended to extend the expiration date to August 22, 2009.

After the rights become exercisable, under certain circumstances, the rights (other than rights held by a 19.9% beneficial owner or an “adverse person”) will entitle the holders to purchase either the Company’s common shares or the common shares of the potential acquirer at a substantially reduced price.

80

NATIONAL PENN BANCSHARES, INC. AND SUBSIDIARIES

Notes to Consolidated Financial Statements - Continued

December 31, 2005 and 2004

12. SHAREHOLDER RIGHTS PLAN - Continued

The Company is generally entitled to redeem the rights at $0.001 per right at any time until the 10th business day following a public announcement that a 19.9% position has been acquired. Rights are not redeemable following an “adverse person” determination.

The Rights Plan was not adopted in response to any specific effort to acquire control of the Company. The issuance of rights had no dilutive effect, did not affect the Company’s reported earnings per share, and was not taxable to the Company or its shareholders.

13. EARNINGS PER SHARE

	Year ended December 31, 2005
	Income		Shares		Per share
	(numerator)		(denominator)		amount
Basic earnings per share	$	59,755		43,328	$	1.38
Net income available to common stockholders
Effect of dilutive securities
Options		-		720		(.02	)
Diluted earnings per share
Net income available to common stockholders
plus assumed conversions	$	59,755		44,048	$	1.36

Options to purchase 1,337,535 shares of common stock at $20.63 to $22.80 per share were outstanding during 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.

	Year ended December 31, 2004
	Income		Shares		Per share
	(numerator)		(denominator)		amount
Basic earnings per share
Net income available to common stockholders	$	47,914		40,797	$	1.17
Effect of dilutive securities
Options		-		892		(.02	)
Diluted earnings per share
Net income available to common stockholders
plus assumed conversions	$	47,914		41,689	$	1.15

Options to purchase 964,516 shares of common stock at $20.70 to $22.80 per share were outstanding during 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.

81

NATIONAL PENN BANCSHARES, INC. AND SUBSIDIARIES

Notes to Consolidated Financial Statements - Continued

December 31, 2005 and 2004

13. EARNINGS PER SHARE - Continued

	Year ended December 31, 2003
	Income		Shares		Per share
	(numerator)		(denominator)		amount
Basic earnings per share
Net income available to common stockholders	$	43,354		37,208	$	1.17
Effect of dilutive securities
Options		-		935		(.03	)
Diluted earnings per share
Net income available to common stockholders
plus assumed conversions	$	43,354		38,143	$	1.14

Options to purchase 510,938 shares of common stock at $20.70 to $21.20 per share were outstanding during 2003. They were not included in the computation of diluted earnings per share because the option exercise price was greater than the average market price.

14. COMMITMENTS AND CONTINGENT LIABILITIES

LEASE COMMITMENTS

Future minimum payments under non-cancelable operating leases are due as follows (in thousands):

Year ending December 31,
2006	$	3,427
2007		2,929
2008		2,264
2009		2,142
2010		1,750
Thereafter		10,053
	$	22,565

The total rental expense was approximately $4,246,000, $3,885,000, and $3,462,000 in 2005, 2004 and 2003, respectively.

OTHER

In the normal course of business, the Company has been named as a defendant in various lawsuits. Although the ultimate outcome of these suits cannot be ascertained at this time, it is the opinion of management that the resolution of such suits will not have a material adverse effect on the financial position or results of operations of the Company.

82

NATIONAL PENN BANCSHARES, INC. AND SUBSIDIARIES

Notes to Consolidated Financial Statements - Continued

December 31, 2005 and 2004

15. STOCK-BASED COMPENSATION

The Company maintains a Long-Term Incentive Compensation Plan, approved by shareholders in April 2005 (2005 Plan). A total of 5,000,000 shares of common stock have been made available for options, restricted stock or other stock or stock-based awards to be granted to employees or non-employee directors through November 30, 2014. Options granted under the 2005 Plan vest at such times as are determined by the Compensation Committee at the time of grant, but not before one year from the date of grant or later than five years from the date of grant. There were 418,075 outstanding options under the 2005 Plan at December 31, 2005.

Prior to adoption of the 2005 Plan, the Company maintained an Officers’ and Key Employees’ Stock Compensation Plan (Officers’ Plan). A total of 4,219,593 shares of common stock were made available for option or restricted stock grants through April 2005. Options granted under the Officers’ Plan vest over a five-year period, in 20% increments on each successive anniversary of the date of grant. There are 2,690,849 outstanding options under the Officers’ Plan at December 31, 2005. Options granted under the Company’s predecessor stock option plan for officers and key employees are subject to a vesting schedule commencing at two years and expire ten years and one month from the date of issue. Under that prior plan, there are 146,188 outstanding options at December 31, 2005. No further options may be granted under the Officers’ Plan or its predecessor plan.

In addition, prior to adoption of the 2005 Plan, the Company maintained a Non-Employee Directors’ Stock Option Plan (Directors’ Plan). Under the Directors’ Plan, a total of 539,175 shares of common stock were made available for option grants through January 2004. There are 98,725 outstanding options under the Directors’ Plan at December 31, 2005. No further options may be granted under the Directors’ Plan.

As of December 31, 2005, 631,298 options were outstanding as a result of the issuance of stock options in substitution for stock options of acquired companies outstanding at the time of acquisition. Included in this amount are 56,256 substitute options issued in 2004 as a result of the acquisition of Peoples First, Inc.

83

NATIONAL PENN BANCSHARES, INC. AND SUBSIDIARIES

Notes to Consolidated Financial Statements - Continued

December 31, 2005 and 2004

15. STOCK-BASED COMPENSATION - Continued

A summary of the status of the Company’s fixed option plans is presented below:

	December 31,
	2005					2004					2003
				Weighted average exercise					Weighted average exercise					Weighted average exercise
	Shares			price		Shares			price		Shares			price
Outstanding, beginning of year		3,995,128		$	14.29		4,111,860		$	12.59		3,284,127		$	12.49
Granted		418,575			20.51		640,388			19.06		2,158,055			10.86
Exercised		(406,679	)		9.43		(707,597	)		8.70		(1,206,961	)		9.30
Forfeited		(21,889	)		18.39		(49,523	)		15.24		(123,361	)		11.83
Outstanding, end of year		3,985,135		$	15.41		3,995,128		$	14.29		4,111,860		$	12.59
Options exercisable at year-end		2,654,949					2,627,110					2,723,785
Weighted average fair value of
options granted during the year				$	5.29				$	6.26				$	6.82

The following table summarizes information about nonqualified options outstanding at December 31, 2005:

	Options outstanding						Options exercisable
			Weighted
	Number		average				Number
	outstanding at		remaining		Weighted		outstanding at		Weighted
Range of	December 31,		contractual		average		December 31,		average
exercise prices	2005		life (years)		exercise price		2005		exercise price
$2.29 - 4.56		62,235		2.3	$	4.08		62,235	$	4.08
4.57 - 6.84		7,297		2.4		5.55		7,297		5.55
6.85 - 9.12		633,497		3.6		8.06		633,497		8.06
9.13 - 11.40		300,250		4.9		11.33		300,250		11.33
11.41 - 13.68		475,222		3.2		13.37		475,222		13.37
13.69 - 15.96		1,110,333		5.7		14.97		860,488		14.97
15.97 - 18.24		26,038		7.0		16.24		26,038		16.24
18.25 - 20.52		26,875		9.4		18.74		-		-
$20.53 - 22.80		1,343,388		8.9		21.38		289,922		21.36
		3,985,135		6.1	$	15.41		2,654,949	$	13.05

84

NATIONAL PENN BANCSHARES, INC. AND SUBSIDIARIES

Notes to Consolidated Financial Statements - Continued

December 31, 2005 and 2004

16.FINANCIAL INSTRUMENTS WITH OFF-BALANCE-SHEET RISK

The Company is a party to financial instruments with off-balance-sheet risk in the normal course of business to meet the financing needs of its customers and to reduce its own exposure to fluctuations in interest rates. These financial instruments include commitments to extend credit, standby letters of credit and interest rate swaps. Those instruments involve, to varying degrees, elements of credit and interest rate risk in excess of the amount recognized in the consolidated balance sheets. The contract or notional amounts of those instruments reflect the extent of involvement the Company has in particular classes of financial instruments. At December 31, 2005, the Company had mortgage loan interest rate lock commitments related to loans held for sale with a notional amount of approximately $28.7 million. Likewise, the Company had offsetting investor interest rate lock commitments of approximately $28.7 million whereby the investor has agreed to purchase the mortgage at or near the time of funding. There was an additional $18.6 million in investor rate lock commitments for loans held for sale at December 31, 2005. The amount of these commitments at December 31, 2004 was $23.5 million.

The Company’s exposure to credit loss in the event of non-performance by the other party to the financial instrument for commitments to extend credit and standby letters of credit is represented by the contractual notional amount of these instruments. The Company uses the same credit policies in making commitments and conditional obligations as it does for on-balance-sheet instruments. For interest rate swaps, the contract or notional amounts do not represent exposure to credit loss. The Company controls the credit risk of its interest rate swap agreements through credit approvals, limits and monitoring procedures.

Unless otherwise noted, the Company does not require collateral or other security to support financial instruments with credit risk. The contract or notional amounts as of December 31, 2005 and 2004, are as follows (in thousands):

	2005		2004
Financial instruments whose contract amounts represent
credit risk
Commitments to extend credit	$	1,024,218	$	960,560
Commitments to fund mortgages held for sale		28,660		23,549
Letters of credit		95,987		89,342

Commitments to extend credit are agreements to lend to a customer as long as there is no violation of any condition established in the contract. Commitments generally have fixed expiration dates or other termination clauses and may require payment of a fee. Since many of the commitments are expected to expire without being drawn upon, the total commitment amounts do not necessarily represent future cash requirements. The Company evaluates each customer’s creditworthiness on a case-by-case basis. The amount of collateral obtained, if deemed necessary by the Company upon extension of credit, is based on management’s credit evaluation. Collateral held varies but may include personal or commercial real estate, accounts receivable, inventory and equipment.

85

NATIONAL PENN BANCSHARES, INC. AND SUBSIDIARIES

Notes to Consolidated Financial Statements - Continued

December 31, 2005 and 2004

16.FINANCIAL INSTRUMENTS WITH OFF-BALANCE-SHEET RISK - Continued

Standby letters of credit are conditional commitments issued by the Company to guarantee the performance of a customer to a third party. Those guarantees are primarily issued to support public and private borrowing arrangements, including commercial paper, bond financing and similar transactions. The Company defines the fair value of these letters of credit as the fees paid by the customer or similar fees collected on similar instruments. The Company amortizes the fees collected over the life of the instrument. Management, based upon their periodic analysis, established a SFAS No. 5 reserve which was approximately $456,000 and $656,000 at December 31, 2005 and 2004, respectively. The standby letters of credit expire as follows: $57,242,000 in 2006, $38,672,000 by 2009, and the remaining $73,000 after 2009. The Company also obtains collateral, such as real estate or liens on their customer’s assets depending on the customer, for these types of commitments. The Company would reduce any potential liability based upon estimated proceeds obtained in liquidation of the collateral held. Fair values of unrecognized financial instruments including commitments to extend credit and the fair value of letters of credit are considered immaterial. The credit risk involved in issuing letters of credit is essentially the same as that involved in extending loan facilities to customers. The extent of collateral held for those commitments at December 31, 2005, varies up to 100%; the average amount collateralized is 77%.

Interest rate swap transactions generally involve the exchange of fixed and floating rate interest payment obligations without the exchange of the underlying principal amounts. The Company has used swaps as part of its asset and liability management process with the objective of hedging the relationship between money market deposits that are used to fund prime rate loans. Past experience has shown that as the prime interest rate changes, rates on money market deposits do not change with the same volatility. The interest rate swaps have the effect of converting the rates on money market deposit accounts to a more market-driven floating rate typical of prime in order for the Company to recognize a more even interest rate spread on this business segment. At December 31, 2004, the Company’s interest rate swaps matured.

86

NATIONAL PENN BANCSHARES, INC. AND SUBSIDIARIES

Notes to Consolidated Financial Statements - Continued

December 31, 2005 and 2004

16.FINANCIAL INSTRUMENTS WITH OFF-BALANCE-SHEET RISK - Continued

In 2004 and 2003, the interest rate swaps had the effect of increasing the Company’s net interest income by $914,000, and $1,485,000 respectively, over what would have been realized had the Company not entered into the swap agreements. The Company had no interest rate swap contracts in 2005.

17. FAIR VALUE OF FINANCIAL INSTRUMENTS

SFAS No. 107, Disclosures about Fair Value of Financial Instruments, requires disclosure of the estimated fair value of an entity’s assets and liabilities considered to be financial instruments. For the Company, as for most financial institutions, the majority of its assets and liabilities are considered to be financial instruments as defined in SFAS No. 107. However, many of such instruments lack an available trading market as characterized by a willing buyer and willing seller engaging in an exchange transaction. Also, it is the Company’s general practice and intent to hold its financial instruments to maturity and to not engage in trading or sales activities. Therefore, the Company had to use significant estimations and present value calculations to prepare this disclosure.

Changes in assumptions or methodologies used to estimate fair values may materially affect the estimated amounts. Also, management is concerned that there may not be reasonable comparability between institutions due to the wide range of permitted assumptions and methodologies in the absence of active markets. This lack of uniformity gives rise to a high degree of subjectivity in estimating financial instrument fair values.

Fair values have been estimated using data that management considered the best available and estimation methodologies deemed suitable for the pertinent category of financial instrument. The estimation methodologies, resulting fair values and recorded carrying amounts at December 31, 2005 and 2004, were as follows (in thousands):

	December 31, 2005				December 31, 2004
	Carrying		Estimated fair		Carrying		Estimated fair
	amount		value		amount		value
Cash and cash equivalents	$	122,459	$	122,459	$	93,894	$	93,894
Investment securities available for sale		941,106		941,106		1,098,836		1,098,836
Investment securities held to maturity		150,608		147,628		90,967		90,621

Fair value of loans and deposits with floating interest rates is generally presumed to approximate the recorded carrying amounts. Financial instruments actively traded in a secondary market have been valued using quoted available market prices.

87

NATIONAL PENN BANCSHARES, INC. AND SUBSIDIARIES

Notes to Consolidated Financial Statements - Continued

December 31, 2005 and 2004

17. FAIR VALUE OF FINANCIAL INSTRUMENTS - Continued

Fair value of financial instruments with stated maturities has been estimated using present value cash flow, discounted at a rate approximating current market for similar assets and liabilities (in thousands).

 

	December 31, 2005				December 31, 2004
	Carrying		Estimated fair		Carrying		Estimated fair
	amount		value		amount		value
Deposits with stated maturities	$	1,257,769	$	1,254,815	$	861,948	$	879,671
Repurchase agreements, federal funds
purchased and short-term borrowings		428,771		428,771		514,051		514,051
Long-term borrowings		248,412		288,640		229,926		253,106
Subordinated debt		127,063		149,773		127,063		155,081

Fair value of financial instrument liabilities with no stated maturities has been estimated to equal the carrying amount (the amount payable on demand), totaling $2.05 billion for 2005 and $2.28 billion for 2004.

The fair value of the net loan portfolio has been estimated using present value cash flow, discounted at the treasury rate adjusted for non-interest operating costs and giving consideration to estimated prepayment risk and credit loss factors (in thousands).

	December 31, 2005				December 31, 2004
	Carrying		Estimated fair		Carrying		Estimated fair
	amount		value		amount		value
Net loans	$	2,993,744	$	3,094,186	$	2,816,849	$	2,939,416

The fair value of commitments to extend credit is estimated based on the amount of unamortized deferred loan commitment fees. The fair value of letters of credit is based on the amount of unearned fees plus the estimated cost to terminate the letters of credit.

88

NATIONAL PENN BANCSHARES, INC. AND SUBSIDIARIES

Notes to Consolidated Financial Statements - Continued

December 31, 2005 and 2004

18.REGULATORY MATTERS

National Penn Bank is required to maintain average reserve balances with the Federal Reserve Bank. The average amount of these balances for the year ended December 31, 2005, was approximately $14,750,000.

Dividends are paid by the Company from its assets, which are mainly provided by dividends paid by National Penn Bank. However, certain restrictions exist regarding the ability of National Penn Bank to transfer funds to the Company in the form of cash dividends, loans or advances. Under the restrictions in 2006, National Penn Bank, without prior approval of bank regulators, can declare dividends to the Company totaling $54,498,000 plus additional amounts equal to the net earnings of National Penn Bank for the period January 1, 2006, through the date of declaration less dividends previously paid in 2006.

The Company and National Penn Bank are subject to various regulatory capital requirements administered by the federal banking agencies. Failure to meet minimum capital requirements can initiate certain mandatory - and possible additional discretionary - actions by regulators that, if undertaken, could have a direct material effect on the Company’s consolidated financial statements. Under capital adequacy guidelines and the regulatory framework for prompt corrective action, National Penn Bank must meet specific capital guidelines that involve quantitative measures of National Penn Bank’s assets, liabilities and certain off-balance-sheet items as calculated under regulatory accounting practices. National Penn Bank’s capital amounts and classification are also subject to qualitative judgments by the regulators about components, risk weightings and other factors.

Quantitative measures established by regulations to ensure capital adequacy require National Penn Bank and the Company to maintain minimum amounts and ratios (set forth in the following table) of total and Tier I capital (as defined in the regulations) to risk-weighted assets, and of Tier I capital to average assets. Management believes, as of December 31, 2005, that National Penn Bank and the Company meet all capital adequacy requirements to which they are subject.

89

NATIONAL PENN BANCSHARES, INC. AND SUBSIDIARIES

Notes to Consolidated Financial Statements - Continued

December 31, 2005 and 2004

18. REGULATORY MATTERS - Continued

As of December 31, 2005, NPB met all regulatory requirements for classification as well capitalized under the regulatory framework for prompt corrective action. To be categorized as well capitalized, NPB must maintain minimum total risk-based, core risk-based and core leverage ratios as set forth in the table. There are no conditions or events that management believes have changed the institution’s category.

	Actual					For capital adequacy purposes					To be well capitalized under prompt corrective action provisions
	Amount		Ratio			Amount		Ratio			Amount		Ratio
	(dollars in thousands)
As of December 31, 2005
Total capital (to risk-weighted assets)
National Penn Bancshares, Inc.	$	406,874		11.81	%	$	275,629		8.00	%		N/A		N/A
National Penn Bank		360,441		10.60	%		271,918		8.00	%	$	339,897		10.00	%
Tier I capital (to risk-weighted assets)
National Penn Bancshares, Inc.		360,866		10.47	%		137,814		4.00	%		N/A		N/A
National Penn Bank		317,786		9.35	%		135,959		4.00	%		203,938		6.00	%
Tier I capital (to average assets)
National Penn Bancshares, Inc.		360,866		8.36	%		172,677		4.00	%		N/A		N/A
National Penn Bank		317,786		7.43	%		171,146		4.00	%		213,932		5.00	%
As of December 31, 2004
Total capital (to risk-weighted assets)
National Penn Bancshares, Inc.	$	366,955		11.27	%	$	260,437		8.00	%		N/A		N/A
National Penn Bank		327,239		10.19	%		256,995		8.00	%	$	321,244		10.00	%
Tier I capital (to risk-weighted assets)
National Penn Bancshares, Inc.		326,053		10.02	%		130,218		4.00	%		N/A		N/A
National Penn Bank		286,868		8.93	%		128,497		4.00	%		192,746		6.00	%
Tier I capital (to average assets)
National Penn Bancshares, Inc.		326,053		7.86	%		165,896		4.00	%		N/A		N/A
National Penn Bank		286,868		7.00	%		163,949		4.00	%		204,936		5.00	%

90

NATIONAL PENN BANCSHARES, INC. AND SUBSIDIARIES

Notes to Consolidated Financial Statements - Continued

December 31, 2005 and 2004

19.CONDENSED FINANCIAL INFORMATION - PARENT COMPANY ONLY

The following is a summary of selected financial information of National Penn Bancshares, Inc., parent company only (in thousands):

CONDENSED BALANCE SHEETS

	December 31,
	2005		2004
Assets
Cash	$	11	$	1,073
Investment in Bank subsidiaries, at equity		521,200		505,866
Investment in other subsidiaries, at equity		52,753		54,049
Other assets		1,954		2,224
	$	575,918	$	563,212
Liabilities and shareholders’ equity
Subordinated debt	$	127,063	$	127,063
Other liabilities		3,967		8,024
Shareholders’ equity		444,888		428,125
	$	575,918	$	563,212

91

NATIONAL PENN BANCSHARES, INC. AND SUBSIDIARIES

Notes to Consolidated Financial Statements - Continued

December 31, 2005 and 2004

19. CONDENSED FINANCIAL INFORMATION - PARENT COMPANY ONLY - Continued

CONDENSED STATEMENTS OF INCOME

	Year ended December 31,
	2005			2004			2003
Income
Equity in undistributed net earnings of subsidiaries	$	33,092		$	25,587		$	4,921
Dividends from subsidiary		32,500			27,113			34,149
Interest and other income		228			216			29
		65,820			52,916			39,099
Expense
Interest on subordinated debentures		8,936			7,249			5,119
Interest on long-term borrowings		-			19			121
Other operating expenses		271			311			68
		9,207			7,579			5,308
Income before income tax benefit		56,613			45,337			33,791
Income tax benefit		(3,142	)		(2,577	)		(942	)
Income from continuing operations		59,755			47,914			34,733
Income from discontinued operations		-			-			8,621
Net income	$	59,755		$	47,914		$	$43,354

92

NATIONAL PENN BANCSHARES, INC. AND SUBSIDIARIES

Notes to Consolidated Financial Statements - Continued

December 31, 2005 and 2004

19. CONDENSED FINANCIAL INFORMATION - PARENT COMPANY ONLY - Continued

CONDENSED STATEMENTS OF CASH FLOWS

	Year ended December 31,
	2005			2004			2003
Cash flows from operating activities
Net income	$	59,755		$	47,914		$	43,354
Equity in undistributed net earnings of subsidiaries		(33,092	)		(25,587	)		8,459
Equity in discontinued subsidiary		-			--			(8,621	)
(Increase) decrease in other assets		270			(335	)		5,005
(Decrease) increase in other liabilities		(4,056	)		(7,412	)		10,660
Net cash provided by operating activities		22,877			14,580			58,857
Cash flows from investing activities
Cash received for business sold		-			-			34,500
Cash paid to acquire businesses		-			(43,945	)		(54,400	)
Sale or repayment of investments in subsidiaries		2,327			34,648			-
Additional investment in subsidiaries, at equity		-			(38,453	)		(1,998	)
Net cash (used in) provided by investing activities		2,327			(47,750	)		(21,898	)
Cash flows from financing activities
Repayment of long-term debt		-			(3,938	)		(5,250	)
Proceeds from issuance of subordinated debt		-			61,857			-
Proceeds from issuance of stock		10,104			12,349			4,890
Purchase of treasury stock		(8,397	)		(10,852	)		(15,339	)
Cash dividends		(27,973	)		(25,199	)		(21,234	)
Net cash (used in) provided by financing activities		(26,266	)		34,217			(36,933	)
Net (decrease) increase in cash and cash equivalents		(1,062	)		1,047			26
Cash and cash equivalents at beginning of year		1,073			26			-
Cash and cash equivalents at end of year	$	11		$	1,073		$	26

93

NATIONAL PENN BANCSHARES, INC. AND SUBSIDIARIES

Notes to Consolidated Financial Statements - Continued

December 31, 2005 and 2004

20.SEGMENT INFORMATION

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 NPB. For example, commercial lending is dependent upon the ability of NPB 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 NPITC, National Penn Life Insurance Company, NP Leasing, National Penn Capital Advisors, Inc., National Penn Insurance Agency, Inc., 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 inter-segment revenues, cash and investment in subsidiaries.

94

NATIONAL PENN BANCSHARES, INC. AND SUBSIDIARIES

Notes to Consolidated Financial Statements - Continued

December 31, 2005 and 2004

20. SEGMENT INFORMATION - Continued

Reportable segment-specific information and reconciliation to consolidated financial information is as follows (in thousands):

	Community
	Banking		Other			Consolidated
December 31, 2005
Total assets	$	4,021,383	$	579,226		$	4,600,609
Total deposits		3,309,046		-			3,309,046
Net interest income (loss)		153,847		(5,198	)		148,649
Total non-interest income		40,782		16,234			57,016
Total non-interest expense		105,663		17,440			123,103
Net income (loss)		64,065		(4,310	)		59,755
December 31, 2004
Total assets	$	3,912,837	$	565,956		$	4,478,793
Total deposits		3,143,193		-			3,143,193
Net interest income (loss)		143,275		(4,993	)		138,282
Total non-interest income		34,000		12,774			46,774
Total non-interest expense		104,567		12,924			117,491
Net income (loss)		52,076		(4,162	)		47,914
December 31, 2003
Total assets	$	3,109,969	$	402,605		$	3,512,574
Total deposits		2,435,296		-			2,435,296
Net interest income (loss)		118,636		(4,087	)		114,549
Total non-interest income		30,063		11,222			41,285
Total non-interest expense		92,357		10,676			103,033
Net income (loss) from continuing operations		38,509		(3,776	)		34,733
Net income from discontinued operations		1,935		6,686			8,621
Net income (loss)		40,444		2,910			43,354

95

NATIONAL PENN BANCSHARES, INC. AND SUBSIDIARIES

Notes to Consolidated Financial Statements - Continued

December 31, 2005 and 2004

21. QUARTERLY CONSOLIDATED FINANCIAL DATA (UNAUDITED)

The following represents summarized quarterly financial data of the Company, which, in the opinion of management, reflects all adjustments (comprising only normal recurring accruals) necessary for a fair presentation. Net income per share of common stock has been restated to retroactively reflect certain stock dividends.

(dollars in thousands, except per share data)
	Three months ended
2005	Dec. 31			Sept. 30		June 30		March 31
Interest income	$	63,448		$	62,308	$	59,893	$	56,937
Net interest income		36,805			37,473		37,385		36,986
Provision for loan losses		750			750		950		750
Net gains (losses) on sale of investment securities		(235	)		181		646		(37	)
Income before income taxes		21,080			19,299		19,881		19,102
Net income		16,259			14,807		14,679		14,010
Earnings per share of common stock - basic		0.37			0.34		0.34		0.33
Earnings per share of common stock - diluted		0.37			0.34		0.33		0.32

	Three months ended
2004	Dec. 31		Sept. 30		June 30		March 31
Interest income	$	55,243	$	53,133	$	46,225	$	44,174
Net interest income		37,288		37,165		32,404		31,425
Provision for loan losses		612		1,225		1,200		1,763
Net gains (losses) on sale of investment securities		645		100		--		(196	)
Income before income taxes		13,507		18,082		16,273		14,903
Net income		10,633		13,733		12,180		11,368
Earnings per share of common stock - basic		0.24		0.32		0.31		0.30
Earnings per share of common stock - diluted		0.24		0.31		0.31		0.29

Net income in fourth quarter 2004 included a special charge of $3.369 million, net of taxes and related adjustments, for losses attributable to the fraud disclosed in Note 1. During the fourth quarter 2005, the Company recorded a recovery of $2.288 million, net of taxes, on this fraud loss.

96

REPORT OF INDEPENDENT REGISTERED PUBLIC ACCOUNTING FIRM

Board of Directors

National Penn Bancshares, Inc.

We have audited the accompanying consolidated balance sheets of National Penn Bancshares, Inc. (a Pennsylvania corporation) and its subsidiaries as of December 31, 2005 and 2004, and the related consolidated statements of income, shareholders' equity, and cash flows for each of the three years in the period ended December 31, 2005.  These financial statements are the responsibility of the Company's management.  Our responsibility is to express an opinion on these financial statements based on our audits.

We conducted our audits in accordance with the standards of the Public Company Accounting Oversight Board (United States).  Those standards require that we plan and perform the audit to obtain reasonable assurance about whether the financial statements are free of material misstatement.  An audit includes examining, on a test basis, evidence supporting the amounts and disclosures in the financial statements.  An audit also includes assessing the accounting principles used and significant estimates made by management, as well as evaluating the overall financial statement presentation.  We believe that our audits provide a reasonable basis for our opinion.

In our opinion, the financial statements referred to above present fairly, in all material respects, the consolidated financial position of National Penn Bancshares, Inc. and its subsidiaries as of December 31, 2005 and 2004, and the consolidated results of its operations and its cash flows for each of the three years in the period ended December 31, 2005 in conformity with accounting principles generally accepted in the United States of America.

We also have audited, in accordance with the standards of the Public Company Accounting Oversight Board (United States), the effectiveness of National Penn Bancshares Inc.’s internal control over financial reporting as of December 31, 2005, based on criteria established in Internal Control—Integrated Framework issued by the Committee of Sponsoring Organizations of the Treadway Commission (COSO) and our report dated February 24, 2006 expressed an unqualified opinion on management’s assessment and an unqualified opinion on internal control effectiveness.

/s/Grant Thornton LLP

GRANT THORNTON LLP

Philadelphia, Pennsylvania

February 24, 2006

97

Management’s Report on Internal Control Over Financial Reporting

Our management is responsible for establishing and maintaining adequate internal control over financial reporting as defined in Rules 13a-15(f) and 15d-15(f) under the Securities Exchange Act of 1934. National Penn’s internal control over financial reporting is designed to provide reasonable assurance regarding the reliability of financial reporting and the preparation of financial statements for external purposes in accordance with accounting principles generally accepted in the United States.

National Penn’s internal control over financial reporting includes those policies and procedures that:

 · Pertain to the maintenance of records that, in reasonable detail, accurately and fairly reflect the transactions and dispositions of the assets of National Penn;

 · Provide reasonable assurance that transactions are recorded as necessary to permit preparation of financial statements in accordance with generally accepted accounting principles, and that our receipts and expenditures are being made only in accordance with authorizations of National Penn’s management and directors; and

 · Provide reasonable assurance regarding prevention or timely detection of unauthorized acquisition, use or disposition of National Penn’s assets that could have a material effect on the financial statements.

Because of its inherent limitations, internal control over financial reporting may not prevent or detect misstatements. Also, projections of any evaluation of effectiveness to future periods are subject to the risk that controls may become inadequate because of changes in conditions, or that the degree of compliance with the policies or procedures may deteriorate.

Management, under the supervision and with the participation of National Penn’s Chief Executive Officer and Chief Financial Officer, assessed the effectiveness of National Penn’s internal control over financial reporting as of December 31, 2005. In making its assessment of internal control over financial reporting, management used the criteria set forth by the Committee of Sponsoring Organizations of the Treadway Commission (COSO) in Internal Control-Integrated Framework.

Based on this assessment, management believes that, as of December 31, 2005, National Penn’s internal control over financial reporting is effective based on these criteria.

National Penn’s independent registered public accounting firm has issued an attestation report on management’s assessment of National Penn’s internal control over financial reporting. That report appears in this Annual Report on Form 10-K immediately following this report.

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REPORT OF INDEPENDENT REGISTERED PUBLIC ACCOUNTING FIRM

Board of Directors

National Penn Bancshares, Inc.

We have audited management's assessment, included in the accompanying Management’s Report on Internal Control Over Financial Reporting, that National Penn Bancshares, Inc. (a Pennsylvania corporation) maintained effective internal control over financial reporting as of December 31, 2005, based on criteria established in Internal Control—Integrated Framework issued by the Committee of Sponsoring Organizations of the Treadway Commission (COSO). National Penn Bancshares Inc.’s management is responsible for maintaining effective internal control over financial reporting and for its assessment of the effectiveness of internal control over financial reporting. Our responsibility is to express an opinion on management's assessment and an opinion on the effectiveness of the company's internal control over financial reporting based on our audit.

We conducted our audit in accordance with the standards of the Public Company Accounting Oversight Board (United States). Those standards require that we plan and perform the audit to obtain reasonable assurance about whether effective internal control over financial reporting was maintained in all material respects. Our audit included obtaining an understanding of internal control over financial reporting, evaluating management's assessment, testing and evaluating the design and operating effectiveness of internal control, and performing such other procedures as we considered necessary in the circumstances. We believe that our audit provides a reasonable basis for our opinions.

A company's internal control over financial reporting is a process designed to provide reasonable assurance regarding the reliability of financial reporting and the preparation of financial statements for external purposes in accordance with generally accepted accounting principles. A company's internal control over financial reporting includes those policies and procedures that (1) pertain to the maintenance of records that, in reasonable detail, accurately and fairly reflect the transactions and dispositions of the assets of the company; (2) provide reasonable assurance that transactions are recorded as necessary to permit preparation of financial statements in accordance with generally accepted accounting principles, and that receipts and expenditures of the company are being made only in accordance with authorizations of management and directors of the company; and (3) provide reasonable assurance regarding prevention or timely detection of unauthorized acquisition, use, or disposition of the company's assets that could have a material effect on the financial statements.

Because of its inherent limitations, internal control over financial reporting may not prevent or detect misstatements. Also, projections of any evaluation of effectiveness to future periods are subject to the risk that controls may become inadequate because of changes in conditions, or that the degree of compliance with the policies or procedures may deteriorate.

In our opinion, management's assessment that National Penn Bancshares, Inc. maintained effective internal control over financial reporting as of December 31, 2005, is fairly stated, in all material respects, based on criteria established in Internal Control—Integrated Framework issued by the Committee of Sponsoring Organizations of the Treadway Commission (COSO). Also in our opinion, National Penn Bancshares, Inc. maintained, in all material respects, effective internal control over financial reporting as of December 31, 2005, based on criteria established in Internal Control—Integrated Framework issued by the Committee of Sponsoring Organizations of the Treadway Commission (COSO).

We also have audited, in accordance with the standards of the Public Company Accounting Oversight Board (United States), the consolidated balance sheets of National Penn Bancshares, Inc. and its subsidiaries as of December 31, 2005 and 2004, and the related consolidated statements of income, shareholders' equity, and cash flows for each of the three years in the period ended December 31, 2005 and our report dated February 24, 2006 expressed an unqualified opinion on those financial statements.

/s/ Grant Thornton LLP

GRANT THORNTON LLP

Philadelphia, Pennsylvania

February 24, 2006

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Item 9. CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING AND FINANCIAL DISCLOSURE.

None.

Item 9A. 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 December 31, 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 disclosure controls and procedures. Based on that evaluation, the Chief Executive Officer and the Chief Financial Officer concluded that such disclosure controls and procedures are effective in providing 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. Management’s report on internal control over financial reporting as of December 31, 2005, and the related attestation report of the independent registered public accounting firm, Grant Thornton LLP, are included in this Report in Item 8 after the Notes to Consolidated Financial Statements on pages 98 and 99, and are incorporated by reference into this Item 9A.

There were no changes in National Penn’s internal control over financial reporting during the fiscal quarter ended December 31, 2005 that materially affected, or are reasonably likely to materially affect, National Penn’s internal control over financial reporting.

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.

Item 9B. OTHER INFORMATION.

None.

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PART III

Item 10. DIRECTORS AND EXECUTIVE OFFICERS OF THE REGISTRANT.

Information relating to executive officers of National Penn is included under Item 4A in Part I of this Report. Information relating to directors of National Penn and compliance with Section 16(a) of the Securities Exchange Act of 1934 is incorporated by reference to the section captioned “Election of Directors” and the subsection captioned “Section 16(a) Beneficial Ownership Reporting Compliance” of National Penn’s definitive Proxy Statement to be used in connection with National Penn’s 2006 Annual Meeting of Shareholders (the “Proxy Statement”).

National Penn maintains in effect a written Code of Conduct that applies to National Penn’s directors, executive officers, employees and others acting on behalf of National Penn, including our principal executive officer, principal financial officer, principal accounting officer, controller, and any other person performing similar functions. A copy of the Code of Conduct is included in this Report as Exhibit 14.1.

Item 11. EXECUTIVE COMPENSATION.

Information required by this item is incorporated by reference to the subsection captioned “Director Compensation” and the section captioned “Execution Compensation” of the Proxy Statement.

Item 12. SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT AND RELATED STOCKHOLDER MATTERS.

Information required by this item is incorporated by reference to the sections captioned “Stock Ownership” and “Equity Compensation Plan Table” of the Proxy Statement.

Item 13. CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS.

Information required by this item is incorporated by reference to the subsection captioned “Related Party and Similar Transactions” of the Proxy Statement.

Item 14. PRINCIPAL ACCOUNTING FEES AND SERVICES.

Information required by this item is incorporated by reference to the subsection captioned “Audit Committee Report” of the Proxy Statement.

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PART IV

Item 15. EXHIBITS, FINANCIAL STATEMENT SCHEDULES.

(a) 1. Financial Statements.

The following consolidated financial statements are included in Part II, Item 8, of this Report:

National Penn Bancshares, Inc. and Subsidiaries.

Consolidated Balance Sheets.

Consolidated Statements of Income.

Consolidated Statement of Changes in Shareholders’ Equity.

Consolidated Statements of Cash Flows.

Notes to Consolidated Financial Statements.

2. Financial Statement Schedules.

Financial statement schedules are omitted because the required information is either not applicable, not required, or is shown in the financial statements or in their notes.

(b) Exhibits.

2.1	Agreement dated February 10, 2003 among National Penn Bancshares, Inc., Panasia Bank, N.A., and Woori America Bank. (Schedules are omitted pursuant to Regulation S-K, Item 601(d)(2); National Penn agrees to furnish a copy of such schedules to the Securities and Exchange Commission upon request.) (Incorporated by reference to Exhibit 2.1 to National Penn’s Report on Form 8-K dated February  10, 2003).
2.2	Guaranty Agreement dated February 10, 2003 of Woori Bank in favor of National Penn Bancshares, Inc. and Panasia Bank, N.A. (Incorporated by reference to Exhibit 2.2 to National Penn’s Report on Form 8-K dated February 10, 2003.)
2.3	Agreement and Plan of Merger dated April 30, 2003, by and among National Penn Bancshares, Inc., National Penn Bank and HomeTowne Heritage Bank. (Schedules are omitted pursuant to Regulation S-K, Item 601(d)(2); National Penn agrees to furnish a copy of such schedules to the Securities and Exchange Commission upon request.) (Incorporated by reference to Exhibit 2.1 to National Penn’s Report on Form 8-K dated April 23, 2003, as filed on May 2, 2003.)
2.4	Form of Letter Agreement between National Penn Bancshares, Inc. and directors of HomeTowne Heritage Bank. (Incorporated by reference to Exhibit 2.2 to National Penn’s Report on Form 8-K dated April 23, 2003, as filed on May 2, 2003.)
2.5	Agreement dated December 17, 2003 between National Penn Bancshares, Inc. and Peoples First, Inc. (Schedules are omitted pursuant to Regulation S-K, Item 601(d)(2); National Penn agrees to furnish a copy of such schedules to the Securities and Exchange Commission upon request.) (Incorporated by reference to Exhibit 2.1 to National Penn’s Report on Form 8-K dated December 17, 2003, as filed on December 19, 2003.)
2.6	Form of Letter Agreement between Peoples First, Inc. directors, executive officers and five percent shareholders and National Penn Bancshares, Inc. (Incorporated by reference to Exhibit 2.2 to National Penn’s Report on Form 8-K dated December 17, 2003.)
2.7	Agreement dated September 6, 2005 between National Penn Bancshares, Inc. and Nittany Financial Corporation. (Schedules are omitted pursuant to Regulation S-K, Item 601(d)(2); National Penn agrees to furnish a copy of such schedules to the Securities and Exchange Commission upon request.) (Incorporated by reference to Exhibit 2.1 to National Penn’s Report on Form 8-K dated September 7, 2005, as filed on September 7, 2005.)

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2.8	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, as filed on September 7, 2005.)
3.1	Articles of Incorporation, as amended, of National Penn Bancshares, Inc. (Incorporated by reference to Exhibit 3.1 to National Penn’s Quarterly Report on Form 10-Q for the quarter ended June 30, 2004, as filed on August 5, 2004.)
3.2	Bylaws, as amended, of National Penn Bancshares, Inc. (Incorporated by reference to Exhibit 3.1 to National Penn’s Report on Form 8-K dated January 25, 2006, as filed on January 25, 2006.)
4.1	Form of Trust Agreement between National Penn Bancshares, Inc. and Christiana Bank & Trust Company, as Trustee. (Incorporated by reference to Exhibit 4.1 to National Penn’s Registration Statement Nos. 333-97361 and 333-97361-01 on Form S-3, as filed on July 30, 2002.)
4.2	Form of Amended and Restated Trust Agreement among National Penn Bancshares, Inc., Christiana Bank & Trust Company, as Property Trustee, and Christiana Bank & Trust Company, as Delaware Trustee. (Incorporated by reference to Exhibit 4.2 to National Penn’s Registration Statement Nos. 333-97361 and 333-97361-01 on Form S-3, as filed on August 6, 2002.)
4.3	Form of Subordinated Debenture Indenture between National Penn Bancshares, Inc. and Christiana Bank & Trust Company, as Trustee. (Incorporated by reference to Exhibit 4.4 to National Penn’s Registration Statement Nos. 333-97361 and 333-97361-01 on Form S-3, as filed on August 6, 2002.)
4.4	Form of Preferred Securities Guarantee Agreement between National Penn Bancshares, Inc. and Christiana Bank & Trust Company, as Trustee. (Incorporated by reference to Exhibit 4.6 to National Penn’s Registration Statement Nos. 333-97361 and 333-97361-01 on Form S-3, as filed on August 6, 2002.)
4.5	Term Loan Agreement dated July 11, 2000, between National Penn Bancshares, Inc. and the Northern Trust Company. (Omitted pursuant to Regulation S-K, Item 601(b)(4)(iii); National Penn agrees to furnish a copy of such agreement to the Securities and Exchange Commission upon request.)
4.6	Form of Declaration of Trust between National Penn Bancshares, Inc., as sponsor, and Chase Manhattan Bank USA, National Association. (Incorporated by reference to Exhibit 4.1 to National Penn’s Report on Form 8-K dated February 20, 2004, as filed on February 24, 2004.)
4.7	Form of Amended and Restated Trust Agreement among National Penn Bancshares, Inc., as sponsor, Chase Manhattan Bank USA, National Association, as Delaware Trustee, JPMorgan Chase Bank, as Institutional Trustee, and Gary L. Rhoads and Sandra L. Spayd, as Administrators. (Incorporated by reference to Exhibit 4.2 to National Penn’s Report on Form 8-K dated February 20, 2004, as filed on February 24, 2004.)
4.8	Form of Indenture between National Penn Bancshares, Inc. and JPMorgan Chase Bank, as Trustee. (Incorporated by reference to Exhibit 4.3 to National Penn’s Report on Form 8-K dated February 20, 2004, as filed on February 24, 2004.)
4.9	Form of Guarantee Agreement between National Penn Bancshares, Inc., as Guarantor, and JPMorgan Chase Bank, as Guarantee Trustee. (Incorporated by reference to Exhibit 4.4 to National Penn’s Report on Form 8-K dated February 20, 2004, as filed on February 24, 2004.)
4.10	Form of Declaration of Trust between National Penn Bancshares, Inc., as sponsor, and Wilmington Trust Company. (Incorporated by reference to Exhibit 4.1 to National Penn's Report on Form 8-K dated March 25, 2004, as filed on March 31, 2004.)

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4.11	Form of Amended and Restated Trust Agreement among National Penn Bancshares, Inc., as sponsor, Wilmington Trust Company, as Delaware Trustee, Wilmington Trust Company, as Institutional Trustee, and Gary L. Rhoads and Sandra L. Spayd, as Administrators. (Incorporated by reference to Exhibit 4.2 to National Penn's Report on Form 8-K dated March 25, 2004, as filed on March 31, 2004.)
4.12	Form of Indenture between National Penn Bancshares, Inc. and Wilmington Trust Company, as Trustee. (Incorporated by reference to Exhibit 4.3 to National Penn's Report on Form 8-K dated March 25, 2004, as filed on March 31, 2004.)
4.13	Form of Guarantee Agreement between National Penn Bancshares, Inc., as Guarantor, and Wilmington Trust Company, as Guarantee Trustee. (Incorporated by reference to Exhibit 4.4 to National Penn's Report on Form 8-K dated March 25, 2004, as filed on March 31, 2004.)
4.14	Form of Declaration of Trust between National Penn Bancshares, Inc., as sponsor, and Wells Fargo Delaware Trust Company. (Incorporated by reference to Exhibit 4.1 to National Penn's Report on Form 8-K dated April 7, 2004, as filed on April 13, 2004.)
4.15	Form of Amended and Restated Declaration of Trust among National Penn Bancshares, Inc., as sponsor, Wells Fargo Delaware Trust Company, as Delaware Trustee, Wells Fargo Bank, National Association, as Institutional Trustee, and Gary L. Rhoads and Sandra L. Spayd, as Administrators. (Incorporated by reference to Exhibit 4.2 to National Penn's Report on Form 8-K dated April 7, 2004, as filed on April 13, 2004.)
4.16	Form of Indenture between National Penn Bancshares, Inc. and Wells Fargo Bank, as Institutional Trustee. (Incorporated by reference to Exhibit 4.3 to National Penn's Report on Form 8-K dated April 7, 2004, as filed on April 13, 2004.)
4.17	Form of Guarantee Agreement between National Penn Bancshares, Inc., as Guarantor, and Wells Fargo Bank, National Association, as Guarantee Trustee. (Incorporated by reference to Exhibit 4.4 to National Penn's Report on Form 8-K dated April 7, 2004, as filed on April 13, 2004.)
4.18	Form of Declaration of Trust between National Penn Bancshares, Inc., as sponsor, and Christiana Bank & Trust Company. (Incorporated by reference to Exhibit 4.1 to National Penn’s Report on Form 8-K dated January 25, 2006, as filed on January 25, 2006.)
4.19	Form of Amended and Restated Declaration of Trust among National Penn Bancshares, Inc., as sponsor, Christiana Bank & Trust Company, as Delaware Trustee, LaSalle Bank National Association, as Institutional Trustee, and Gary L. Rhoads and Sandra L. Spayd, as Administrators. (Incorporated by reference to Exhibit 4.2 to National Penn’s Report on Form 8-K dated January 25, 2006, as filed on January 25, 2006.)
4.20	Form of Indenture between National Penn Bancshares, Inc., and LaSalle Bank National Association, as Trustee. (Incorporated by reference to Exhibit 4.3 to National Penn’s Report on Form 8-K dated January 25, 2006, as filed on January 25, 2006.)
4.21	Form of Guarantee Agreement between National Penn Bancshares, Inc., as Guarantor, and LaSalle Bank National Association, as Guarantee Trustee. (Incorporated by reference to Exhibit 4.4 to National Penn’s Report on Form 8-K dated January 25, 2006, as filed on January 25, 2006.)
4.22	Form of Loan Agreement between National Penn Investment Company, as Lender, and National Penn Bancshares, Inc., as Borrower. (Incorporated by reference to Exhibit 4.5 to National Penn’s Report on Form 8-K dated January 25, 2006, as filed on January 25, 2006.)

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4.23	Form of Revolving Credit Note, executed by National Penn Bancshares, Inc. (Incorporated by reference to Exhibit 4.6 to National Penn’s Report on Form 8-K dated January 25, 2006, as filed on January 25, 2006.)
10.1	National Penn Bancshares, Inc. Amended and Restated Dividend Reinvestment Plan. (Incorporated by reference to Exhibit 10.1 to National Penn’s Report on Form 8-K dated March 27, 2002, as filed on April 8, 2002.)
10.2	National Penn Bancshares, Inc. Pension Plan (Amended and Restated Effective January 1, 2001).* (Incorporated by reference to Exhibit 10.2 to National Penn’s Annual Report on Form 10-K for the year ended December 31, 2001.)
10.3	Bernville Bank, N.A. Employees’ Profit Sharing Plan - Plan Compliance and Merger Amendment.* (Incorporated by reference to Exhibit 10.1 to National Penn’s Quarterly Report on Form 10-Q for the quarter ended June 30, 2001.)
10.4	Amendment No. 1 to National Penn Bancshares, Inc. Pension Plan (Amended and Restated Effective January 1, 2001).* (Incorporated by reference to Exhibit 10.1 to National Penn’s Report on Form 8-K dated December 18, 2002, as filed on January 9, 2003.)
10.5	Amendment No. 2 to National Penn Bancshares, Inc. Pension Plan (Amended and Restated Effective January 1, 2001).* (Incorporated by reference to Exhibit 10.1 to National Penn’s Report on Form 8-K dated August 27, 2003, as filed on August 27, 2003.)
10.6	Amendment No. 3 to National Penn Bancshares, Inc. Pension Plan (Amended and Restated Effective January 1, 2001).* (Incorporated by reference to Exhibit 10.1 to National Penn’s Quarterly Report on Form 10-Q for the quarter ended September 30, 2004, as filed on November 5, 2004.)
10.7	Amendment No. 4 to National Penn Bancshares, Inc. Pension Plan (Amended and Restated Effective January 1, 2001).* (Incorporated by reference to Exhibit 10.2 to National Penn’s Quarterly Report on Form 10-Q for the quarter ended September 30, 2004, as filed on November 5, 2004.)
10.8	Amendment No. 5 to National Penn Bancshares, Inc. Pension Plan (Amended and Restated Effective January 1, 2001).* (Incorporated by reference to Exhibit 10.2 to National Penn’s Report on Form 8-K, dated March 29, 2005, as filed on April 6, 2005.)
10.9	Amendment No. 6 to National Penn Bancshares, Inc. Pension Plan (Amended and Restated Effective January 1, 2001).* (Incorporated by reference to Exhibit 10.1 to National Penn’s Report on Form 8-K, dated January 27, 2006, as filed on January 27, 2006.)
10.10	National Penn Bancshares, Inc. Capital Accumulation Plan (Amended and Restated Effective January 1, 1997) (Revised 2001).* (Incorporated by reference to Exhibit 10.2 to National Penn’s Quarterly Report on Form 10-Q for the quarter ended June 30, 2001.)
10.11	Amendment No. 1 to National Penn Bancshares, Inc. Capital Accumulation Plan (Amended and Restated Effective January 1, 1997) (Revised 2001).* (Incorporated by reference to Exhibit 4.2 to National Penn’s Registration Statement No. 333-75730 on Form S-8, as filed on December 21, 2001.)
10.12	Amendment No. 2 to National Penn Bancshares, Inc. Capital Accumulation Plan (Amended and Restated Effective January 1, 1997) (Revised 2001).* (Incorporated by reference to Exhibit 4.6 to National Penn’s Post-Effective Amendment to Registration Statement No. 333-75730 on Form S-8, as filed on January 7, 2002.)
10.13	Amendment No. 3 to National Penn Bancshares, Inc. Capital Accumulation Plan (Amended and Restated Effective January 1, 1997) (Revised 2001).* (Incorporated by reference to Exhibit 10.2 to National Penn’s Report on Form 8-K dated December 18, 2002, as filed on January 9, 2003.)

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10.14	Amendment No. 4 to National Penn Bancshares, Inc. Capital Accumulation Plan (Amended and Restated Effective January 1, 1997).* (Incorporated by reference to Exhibit 10.1 to National Penn’s Quarterly Report on Form 10-Q for the quarterly period ended June 30, 2003.)
10.15	Amendment No. 5 to National Penn Bancshares, Inc. Capital Accumulation Plan (Amended and Restated Effective January 1, 1997).* (Incorporated by reference to Exhibit 10.2 to National Penn’s Report on Form 8-K dated August 27, 2003, as filed on August 27, 2003.)
10.16	Amendment No. 6 to National Penn Bancshares, Inc. Capital Accumulation Plan (Amended and Restated Effective January 1, 1997).* (Incorporated by reference to Exhibit 10.1 to National Penn’s Report on Form 8-K dated December 22, 2004, as filed on December 27, 2004.)
10.17	Amendment No. 7 to National Penn Bancshares, Inc. Capital Accumulation Plan (Amended and Restated Effective January 1, 1997).* (Incorporated by reference to Exhibit 10.2 to National Penn’s Report on Form 8-K dated December 22, 2004, as filed on December 27, 2004.)
10.18	Amendment No. 8 to National Penn Bancshares, Inc. Capital Accumulation Plan (Amended and Restated Effective January 1, 1997).* (Incorporated by reference to Exhibit 10.3 to National Penn’s Report on Form 8-K dated December 22, 2004, as filed on December 27, 2004.)
10.19	Amendment No. 9 to National Penn Bancshares, Inc. Capital Accumulation Plan (Amended and Restated Effective January 1, 1997).* (Incorporated by reference to Exhibit 10.1 to National Penn’s Report on Form 8-K dated March 29, 2005, as filed on April 6, 2005.)
10.20	Amendment No. 10 to National Penn Bancshares, Inc. Capital Accumulation Plan (Amended and Restated Effective January 1, 1997).* (Incorporated by reference to Exhibit 10.1 to National Penn’s Report on Form 8-K dated May 17, 2005, as filed on May 17, 2005.)
10.21	Amendment No. 11 to National Penn Bancshares, Inc. Capital Accumulation Plan (Amended and Restated Effective January 1, 1997).* (Incorporated by reference to Exhibit 10.1 to National Penn’s Report on Form 8-K dated January 27, 2006, as filed on January 27, 2006.)
10.22	National Penn Bancshares, Inc. Amended and Restated Executive Incentive Plan.* (Incorporated by reference to Exhibit 10.1 to National Penn’s Report on Form 8-K dated December 22, 2005, as filed on December 22, 2005.)
10.23	National Penn Bancshares, Inc. Executive Incentive Plan/Performance Goals - Plan Year 2006.* (Incorporated by reference to Exhibit 10.1 of Form 8-K dated January 25, 2006, as filed January 27, 2006.)
10.24	National Penn Bancshares, Inc. Amended and Restated Stock Option Plan.* (Incorporated by reference to Exhibit 10.1 to National Penn’s Report on Form 8-K dated July 12, 2002, as filed on July 16, 2002.)
10.25	National Penn Bancshares, Inc. Amended Officers’ and Key Employees’ Stock Compensation Plan.* (Incorporated by reference to Exhibit 10.1 to National Penn’s Report on Form 8-K dated September 26, 2001, as filed on September 27, 2001.)
10.26	National Penn Bancshares, Inc. Long-Term Incentive Compensation Plan*. (Incorporated by reference to Exhibit 10.1 to National Penn’s Report on Form 8-K dated April 25, 2005, as filed on April 29, 2005).
10.27	National Penn Bancshares, Inc. Directors’ Fee Plan.* (Incorporated by reference to Exhibit 10.3 to National Penn’s Report on Form 8-K dated December 18, 2002, as filed on January 9, 2003.)

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10.28	National Penn Bancshares, Inc. Non-Employee Directors’ Stock Option Plan.* (Incorporated by reference to Exhibit 10.2 to National Penn’s Report on Form 8-K dated September 26, 2001, as filed on September 27, 2001.)
10.29	National Penn Bancshares, Inc. Amended and Restated Employee Stock Purchase Plan.* (Incorporated by reference to Exhibit 10.2 to National Penn’s Report on Form 8-K dated December 20, 2000, as filed on January 1, 2001.)
10.30	National Penn Bancshares, Inc. Elverson Substitute Stock Option Plan.* (Incorporated by reference to Exhibit 4.1 to National Penn’s Registration Statement No. 333-71391 on Form S-8, as filed on January 29, 1999.)
10.31	National Penn Bancshares, Inc. Community Employee Substitute Stock Option Plan.* (Incorporated by reference to Exhibit 4.1 to National Penn’s Registration Statement No. 333-54520 on Form S-8, as filed on January 29, 2001.)
10.32	National Penn Bancshares, Inc. Community Non-Employee Director Substitute Stock Option Plan.* (Incorporated by reference to Exhibit 4.1 to National Penn’s Registration Statement No. 333-54556 on Form S-8, as filed on January 29, 2001.)
10.33	Form of Amended and Restated Director Deferred Fee Agreement between Bernville Bank, N.A. and certain former Bernville Bank, N.A. directors.* (Incorporated by reference to Exhibit 10.18 to National Penn’s Annual Report on Form 10-K for the year ended December 31, 2000.)
10.34	National Penn Bancshares, Inc. FirstService Substitute Incentive Stock Plan.” (Incorporated by reference to Exhibit 10.20 to National Penn’s Annual Report on Form 10-K for the year ended December 31, 2002.)
10.35	National Penn Bancshares, Inc. FirstService Non-Employee Directors Substitute Stock Option Plan.* (Incorporated by reference to Exhibit 10.21 to National Penn’s Annual Report on Form 10-K for the year ended December 31, 2002.)
10.36	National Penn Bancshares, Inc. HomeTowne Heritage Bank Substitute 2000 Employee Stock Option Plan*. (Incorporated by reference to Exhibit 10.1 to National Penn’s Registration Statement No. 333-11376 on Form S-8, as filed on December 19, 2003.)
10.37	National Penn Bancshares, Inc. HomeTowne Heritage Bank Substitute 2000 Non-Employee Directors Stock Option Plan* (Incorporated by reference to Exhibit 10.1 to National Penn’s Registration Statement No. 333-11377 on Form S-8, as filed on December 19, 2003.)
10.38	National Penn Bancshares, Inc. HomeTowne Heritage Bank Substitute 1999 Option Plan* (Incorporated by reference to Exhibit 10.1 to National Penn’s Registration Statement No. 333-11375 on Form S-8, as filed on December 19, 2003.)
10.39	National Penn Bancshares, Inc. Peoples First, Inc. Substitute 2001 Stock Option Plan.* (Incorporated by reference to Exhibit 4.1 to National Penn’s Registration Statement No. 333-116767 on Form S-8, as filed on June 23, 2004.)
10.40	National Penn Bancshares, Inc. Nittany Financial Corp. Substitute Stock Option Plan.* (Incorporated by reference to Exhibit 4.1 to National Penn’s Registration Statement No. 333-131620 on Form S-8, as filed on February 7, 2006.)
10.41	Employment Agreement dated February 4, 2003, among National Penn Bancshares, Inc., National Penn Bank and Wayne R. Weidner.* (Incorporated by reference to Exhibit 10.1 to National Penn’s Report on Form 8-K dated February 4, 2003, as filed on February 4, 2003.)

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10.42	Employment Agreement dated December 18, 2002, among National Penn Bancshares, Inc., National Penn Bank and Glenn E. Moyer.* (Incorporated by reference to Exhibit 10.4 to National Penn’s Report on Form 8-K dated December 18, 2002, as filed on January 9, 2003.)
10.43	Amendatory Agreement dated May 25, 2005, among National Penn Bancshares, Inc., National Penn Bank and Glenn E. Moyer.* (Incorporated by reference to Exhibit 10.1 to National Penn’s Report on Form 8-K dated May 25, 2005, as filed on May 25, 2005.)
10.44	Executive Agreement dated July 23, 1997, among National Penn Bancshares, Inc., National Penn Bank and Gary L. Rhoads.* (Incorporated by reference to Exhibit 10.1 to National Penn’s Quarterly Report on Form 10-Q for the quarter ended September 30, 1997.)
10.45	Amendatory Agreement dated August 26, 1998, among National Penn Bancshares, Inc., National Penn Bank and Gary L. Rhoads.* (Incorporated by reference to Exhibit 10.4 to National Penn’s Quarterly Report on Form 10-Q for the quarter ended September 30, 1998.)
10.46	Amendatory Agreement dated February 24, 1999, among National Penn Bancshares, Inc., National Penn Bank and Gary L. Rhoads.* (Incorporated by reference to Exhibit 10.26 to National Penn’s Annual Report on Form 10-K for the year ended December 31, 2001.)
10.47	Executive Agreement dated July 22, 2004, among National Penn Bancshares, Inc., National Penn Bank and Sandra L. Spayd.* (Incorporated by reference to Exhibit 10.45 to National Penn’s Annual Report on Form 10-K for 2004).
10.48	Executive Agreement dated September 24, 1997, among National Penn Bancshares, Inc., National Penn Bank and Garry D. Koch.* (Incorporated by reference to Exhibit 10.3 to National Penn’s Quarterly Report on Form 10-Q for the quarter ended September 30, 1997.)
10.49	Amendatory Agreement dated August 26, 1998, among National Penn Bancshares, Inc., National Penn Bank and Garry D. Koch.* (Incorporated by reference to Exhibit 10.3 to National Penn’s Quarterly Report on Form 10-Q for the quarter ended September 30, 1998.)
10.50	Executive Agreement dated as of July 23, 1997, among National Penn Bancshares, Inc., National Penn Bank and Sharon L. Weaver.* (Incorporated by reference to Exhibit 10.29 to National Penn’s Annual Report on Form 10-K for the year ended December 31, 1998.)
10.51	Amendatory Agreement dated September 24, 1997, among National Penn Bancshares, Inc., National Penn Bank and Sharon L. Weaver.* (Incorporated by reference to Exhibit 10.30 to National Penn’s Annual Report on Form 10-K for the year ended December 31, 1998.)
10.52	Amendatory Agreement dated August 26, 1998, among National Penn Bancshares, Inc., National Penn Bank and Sharon L. Weaver.* (Incorporated by reference to Exhibit 10.6 to National Penn’s Quarterly Report on Form 10-Q for the quarter ended September 30, 1998.)
10.53	Executive Agreement dated as of August 26, 1998, among National Penn Bancshares, Inc., National Penn Bank and Bruce G. Kilroy.* (Incorporated by reference to Exhibit 10.35 to National Penn’s Annual Report on Form 10-K for the year ended December 31, 2001.)
10.54	Amendatory Agreement dated August 23, 2000, among National Penn Bancshares, Inc., National Penn Bank and Bruce G. Kilroy.* (Incorporated by reference to Exhibit 10.36 to National Penn’s Annual Report on Form 10-K for the year ended December 31, 2001.)
10.55	Executive Agreement dated June 22, 2001, among National Penn Bancshares, Inc., National Penn Bank and Paul W. McGloin.* (Incorporated by reference to Exhibit 10.1 to National Penn’s Report on Form 8-K dated April 24, 2002, as filed on April 29, 2002.)

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10.56	Amendatory Agreement dated January 27, 2002, among National Penn Bancshares, Inc., National Penn Bank and Paul W. McGloin.* (Incorporated by reference to Exhibit 10.2 to National Penn’s Report on Form 8-K dated April 24, 2002, as filed on April 29, 2002.)
10.57	Executive Agreement dated July 2, 2004, among National Penn Bancshares, Inc., National Penn Bank and Michael R. Reinhard.* (Incorporated by reference to Exhibit 10.55 to National Penn’s Annual Report on Form 10-K for 2004.)
10.58	Employment Agreement dated as of September 24, 2002 between National Penn Bank and Donald P. Worthington.* (Incorporated by reference to Exhibit 10.2 to National Penn’s Pre-Effective Amendment No. 1 to Registration Statement No. 333-101689 on Form S-4, as filed on December 31, 2002.)
10.59	Consulting Agreement dated as of December 17, 2003 among National Penn Bancshares, Inc., National Penn Bank and George C. Mason.* (Incorporated by reference to Exhibit 10.3 to National Penn’s Quarterly Report on Form 10-Q for the quarter ended September 30, 2004, as filed on November 5, 2004.)
10.60	Employment Agreement dated as of December 17, 2003, among National Penn Bancshares, Inc., National Penn Bank and Hugh J. Garchinsky.* (Incorporated by reference to Exhibit 10.1 to National Penn’s Registration Statement No. 333-114384 on Form S-4, as filed on April 9, 2004.)
10.61	Executive Agreement dated December 3, 2004, among National Penn Bancshares, Inc., National Penn Bank and Michelle Debkowski.* (Incorporated by reference to Exhibit 10.1 to National Penn’s Report on Form 8-K dated December 3, 2004, as filed on December 8, 2004.)
10.62	Employment Agreement dated October 18, 2004, among National Penn Bancshares, Inc., National Penn Bank and H. Anderson Ellsworth.*
10.63	Amendment to Rights Agreement dated as of August 21, 1999, between National Penn Bancshares, Inc. and National Penn Bank, as Rights Agent (including as Exhibit “A” thereto, the Rights Agreement dated as of August 23, 1989, between National Penn Bancshares, Inc. and National Bank of Boyertown, as Rights Agent). (Incorporated by reference to Exhibit 4.1 to National Penn’s Report on Form 8-K, dated August 21, 1999, as filed on August 26, 1999.)
10.64	Summary Sheet - Non-Employee Directors - Cash Directors’ Fees - 2006.* (Incorporated by reference to Exhibit 10.1 to National Penn’s Report on Form 8-K dated January 25, 2006, as filed on January 25, 2006.)
14.1	Amended and Restated National Penn Bancshares, Inc. Code of Conduct.
21	Subsidiaries of the Registrant.
23	Consent of Independent Registered Public Accounting Firm.
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.)

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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.)

____________________

* Denotes a compensatory plan or arrangement.

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SIGNATURES

Pursuant to the requirements of Section 13 or 15(d) of the Securities Exchange Act of 1934, the Registrant has duly caused this report to be signed on its behalf by the undersigned, thereunto duly authorized.

		NATIONAL PENN BANCSHARES, INC.
		(Registrant)
March 14, 2006	By	/s/ Wayne R. Weidner
		Wayne R. Weidner
		Chairman and
		Chief Executive Officer

Pursuant to the requirements of the Securities Exchange Act of 1934, this report has been signed below by the following persons in the capacities and on the dates indicated:

Signatures	Title
/s/ Thomas A. Beaver	Director	March 14, 2006
Thomas A. Beaver
/s/ John H. Body	Director	March 14, 2006
John H. Body
/s/ J. Ralph Borneman Jr.	Director	March 14, 2006
J. Ralph Borneman, Jr.
/s/ Robert L. Byers	Director	March 14, 2006
Robert L. Byers
/s/ Fred D. Hafer	Director	March 14, 2006
Fred D. Hafer
/s/ Frederick P. Krott	Director	March 14, 2006
Frederick P. Krott
/s/ Patricia L. Langiotti	Director	March 14, 2006
Patricia L. Langiotti
/s/ Kenneth A. Longacre	Director	March 14, 2006
Kenneth A. Longacre

/s/ George C. Mason	Director	March 14, 2006
George C. Mason

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/s/ Glenn E. Moyer	Director and President	March 14, 2006
Glenn E. Moyer
/s/ Robert E. Rigg	Director	March 14, 2006
Robert E. Rigg
/s/ C. Robert Roth	Director	March 14, 2006
C. Robert Roth
/s/ Donald P. Worthington	Director	March 14, 2006
Donald P. Worthington
/s/ Wayne R. Weidner	Director, Chairman	March 14, 2006
Wayne R. Weidner	and Chief Executive Officer
	(Principal Executive Officer)
/s/ Gary L. Rhoads	Treasurer and Group Executive	March 14, 2006
Gary L. Rhoads	Vice President (Principal Financial Officer)
/s/ Michelle H. Debkowski	Senior Vice President (Principal	March 14, 2006
Michelle H. Debkowski	Accounting Officer)

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