UNITED
STATES


SECURITIES
AND EXCHANGE COMMISSION


WASHINGTON,
D.C. 20549





FORM
10-Q





x
            QUARTERLY
      REPORT PURSUANT TO SECTION 13 OR 15(d) OF THESECURITIES
      EXCHANGE ACT OF 1934For
      the quarterly period ended September 30,
      2009ORo
            TRANSITION
      REPORT PURSUANT TO SECTION 13 OR 15(d) OF THESECURITIES
      EXCHANGE ACT OF 1934For
      the transition period from ________________ to
      ________________





000-22537-01
              (Commission
      File Number)NATIONAL
      PENN BANCSHARES, INC.(Exact
      Name of Registrant as Specified in
Charter)





Pennsylvania(State
      or Other Jurisdiction of Incorporation)Philadelphia and Reading
      Avenues,Boyertown,
      PA  19512(Address
      of Principal Executive Offices)





(800)
      822-3321Registrant’s
      telephone number, including area code(Former
      Name or Former Address, if Changed Since Last Report):  N/A





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 xNo  oIndicate
      by check mark whether the registrant has submitted electronically and
      posted on its corporate Web site, if any, every Interactive Data File
      required to be submitted and posted pursuant to Rule 405 of Regulation S-T
      during the preceding 12 months (or for such shorter period that the
      registrant was required to submit and post such files).
              Yes
      o    No
      oIndicate
      by check mark whether the registrant is a large accelerated filer, an
      accelerated filer, a non-accelerated filer or a smaller reporting
      company.  See the definitions of “large accelerated filer,”
      “accelerated filer” and “smaller reporting company” in Rule 12b-2 of the
      Exchange Act.
              Large accelerated filer x                                                                                                                          
      Accelerated filer  o
              Non-accelerated filer   o  (Do
      not check if a smaller reporting company)Smaller
      reporting company oIndicate
      by check mark whether the registrant is a shell company (as defined in
      Rule 12b-2 of the Exchange Act).Yes oNo  x


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





Class
            
            Outstanding at November 5,
    2009Common
      Stock, no stated par value
            
            125,695,948
    shares














TABLE OF
CONTENTS








Part I - Financial
    Information.
            PageItem
      1.
            Financial
      Statements
            3Item
      2.
            Management’s
      Discussion and Analysis ofFinancial
      Condition and Results of Operation
            23Item
      3.
            Quantitative
      and Qualitative Disclosures AboutMarket
      Risk
            37Item
      4.
            Controls
      and
      Procedures
            37Part II - Other
Information.Item
      1.
            Legal
      Proceedings
            38Item  1A.
            Risk
      Factors
            38Item
      2.
            Unregistered
      Sales of Equity Securitiesand
      Use
      of  Proceeds
            47Item
      3.
            Defaults
      Upon Senior
      Securities
            47Item
      4.
            Submission
      of Matters to a Vote ofSecurity
      Holders
            47Item
      5.
            Other
      Information
            47Item
      6.
            Exhibits
            47Signatures
            49Exhibits
            50











2





PART I – FINANCIAL INFORMATION





Item
1.  Financial Statements





NATIONAL
PENN BANCSHARES, INC. AND SUBSIDIARIES


CONSOLIDATED
BALANCE SHEETS




Unaudited(dollars
      in thousands)
              
              September
      30,
              
              
              December
      31,2009
              
              
              2008ASSETSCash
      and due from banks
              
              $
              355,680
              
              
              $
              156,884Interest-bearing
      deposits with banks
              
              
              44,511
              
              
              
              38,946Total
      cash and cash equivalents
              
              
              400,191
              
              
              
              195,830Investment
      securities held to maturity (fair value approximates, $635,398 and
      $284,608 for 2009 and
                2008,
      respectively)
              
              
              612,214
              
              
              
              326,090Investment
      securities available for sale, at fair value
              
              
              1,636,023
              
              
              
              1,593,799Loans
      and leases held for sale
              
              
              9,279
              
              
              
              3,605Loans
      and leases, less allowance for loan and lease losses of $125,490 and
      $84,006 in 2009 and
                2008,
      respectively
              
              
              6,064,915
              
              
              
              6,228,263Premises
      and equipment, net
              
              
              113,712
              
              
              
              119,924Premises
      held for sale
              
              
              812
              
              
              
              3,768Accrued
      interest receivable
              
              
              38,544
              
              
              
              37,127Bank
      owned life insurance
              
              
              197,132
              
              
              
              193,811Goodwill
              
              
              555,789
              
              
              
              558,252Other
      intangible assets, net
              
              
              32,854
              
              
              
              37,496Unconsolidated
      investments under the equity method
              
              
              11,718
              
              
              
              11,874Other
      assets
              
              
              67,127
              
              
              
              93,592TOTAL
      ASSETS
              
              $
              9,740,310
              
              
              $
              9,403,431LIABILITIESNon-interest
      bearing deposits
              
              $
              718,459
              
              
              $
              793,269Interest
      bearing deposits
              
              
              6,080,203
              
              
              
              5,596,617Total
      deposits
              
              
              6,798,662
              
              
              
              6,389,886Securities
      sold under repurchase agreements and federal funds
    purchased
              
              
              628,711
              
              
              
              640,905Short-term
      borrowings
              
              
              7,200
              
              
              
              10,402Long-term
      borrowings
              
              
              778,906
              
              
              
              955,983Subordinated
      debentures ($58,755 and $50,659 at fair value for 2009 and 2008,
      respectively)
              
              
              136,076
              
              
              
              127,980Accrued
      interest payable and other liabilities
              
              
              30,649
              
              
              
              98,280TOTAL
      LIABILITIES
              
              
              8,380,204
              
              
              
              8,223,436SHAREHOLDERS'
      EQUITYPreferred
      stock, no stated par value; authorized 1,000,000 shares,  Series
      A-none issued; Series
                B,
      $1,000 liquidation preference, 5% cumulative; 150,000 shares issued and
      outstanding asof
                9/30/09
      and 12/31/08
              
              
              144,738
              
              
              
              144,076Common
      stock, no stated par value; authorized 250,000,000 shares; issued
      andoutstanding
      2009 - 125,658,738;  2008 - 80,731,751
              
              
              1,227,032
              
              
              
              1,003,110Retained
      earnings (deficit)
              
              
              (16,908
              )
              
              
              65,194Accumulated
      other comprehensive income (loss)
              
              
              5,244
              
              
              
              (32,385
              )TOTAL
      SHAREHOLDERS' EQUITY
              
              
              1,360,106
              
              
              
              1,179,995TOTAL
      LIABILITIES AND SHAREHOLDERS' EQUITY
              
              $
              9,740,310
              
              
              $
              9,403,431The
      accompanying notes are an integral part of these financial
      statements.




3





NATIONAL
PENN BANCSHARES, INC. AND SUBSIDIARIES


UNAUDITED
CONSOLIDATED STATEMENTS OF INCOME





(dollars
      in thousands, except per share data)
              
              Three
      Months Ended Sept 30,
              
              
              Nine
      Months Ended Sept 30,2009
              
              
              2008
              
              
              2009
              
              
              2008INTEREST
      INCOMELoans
      and leases, including fees
              
              $
              84,218
              
              
              $
              97,120
              
              
              $
              253,860
              
              
              $
              282,621Investment
      securitiesTaxable
              
              
              11,896
              
              
              
              14,617
              
              
              
              35,206
              
              
              
              44,072Tax-exempt
              
              
              9,105
              
              
              
              8,913
              
              
              
              27,703
              
              
              
              23,364Federal
      funds sold and deposits in banks
              
              
              21
              
              
              
              67
              
              
              
              66
              
              
              
              566Total
      interest income
              
              
              105,240
              
              
              
              120,717
              
              
              
              316,835
              
              
              
              350,623INTEREST
      EXPENSEDeposits
              
              
              26,069
              
              
              
              35,772
              
              
              
              88,091
              
              
              
              108,137Securities
      sold under repurchase agreements and federal funds
    purchased
              
              
              2,965
              
              
              
              5,187
              
              
              
              9,538
              
              
              
              15,750Short-term
      borrowings
              
              
              -
              
              
              
              89
              
              
              
              -
              
              
              
              130Long-term
      borrowings
              
              
              11,008
              
              
              
              12,721
              
              
              
              34,502
              
              
              
              36,966Total
      interest expense
              
              
              40,042
              
              
              
              53,769
              
              
              
              132,131
              
              
              
              160,983Net
      interest income
              
              
              65,198
              
              
              
              66,948
              
              
              
              184,704
              
              
              
              189,640Provision
      for loan and lease losses
              
              
              52,000
              
              
              
              6,876
              
              
              
              107,025
              
              
              
              13,997Net
      interest income after provision for loan and lease losses
              
              
              13,198
              
              
              
              60,072
              
              
              
              77,679
              
              
              
              175,643NON-INTEREST
      INCOMEWealth
      management income
              
              
              7,670
              
              
              
              8,239
              
              
              
              21,517
              
              
              
              24,362Service
      charges on deposit accounts
              
              
              6,247
              
              
              
              6,880
              
              
              
              18,118
              
              
              
              18,465Bank
      owned life insurance income
              
              
              1,131
              
              
              
              1,702
              
              
              
              3,478
              
              
              
              5,124Other
      operating income
              
              
              3,460
              
              
              
              1,826
              
              
              
              8,902
              
              
              
              7,167Net
      gains (losses) from fair value changes
              
              
              (6,249
              )
              
              
              7,641
              
              
              
              (8,096
              )
              
              
              5,490Net
      gains (losses) on investment securities
              
              
              (863
              )
              
              
              276
              
              
              
              (3,147
              )
              
              
              660IMPAIRMENT
      LOSSES ON INVESTMENT SECURITIES:Impairment
      losses on investment securities
              
              
              (84,704
              )
              
              
              (20,000
              )
              
              
              (99,625
              )
              
              
              (20,000
              )Non credit-related losses on securities not expected to be soldrecognized in other comprehensive loss before tax
              
              
              -
              
              
              
              -
              
              
              
              -
              
              
              
              -(84,704
              )
              
              
              (20,000
              )
              
              
              (99,625
              )
              
              
              (20,000
              )Mortgage
      banking income
              
              
              1,884
              
              
              
              882
              
              
              
              7,138
              
              
              
              2,451Insurance
      commissions and fees
              
              
              3,771
              
              
              
              3,913
              
              
              
              11,744
              
              
              
              11,687Cash
      management and electronic banking fees
              
              
              4,041
              
              
              
              3,917
              
              
              
              11,684
              
              
              
              10,560Equity
      in undistributed net earnings (loss) of unconsolidated
      investments
              
              
              (525
              )
              
              
              1,574
              
              
              
              880
              
              
              
              2,996Total
      non-interest income
              
              
              (64,137
              )
              
              
              16,850
              
              
              
              (27,407
              )
              
              
              68,962NON-INTEREST
      EXPENSESalaries,
      wages and employee benefits
              
              
              30,505
              
              
              
              31,998
              
              
              
              94,771
              
              
              
              92,525Net
      premises and equipment
              
              
              8,104
              
              
              
              8,416
              
              
              
              24,037
              
              
              
              25,442Advertising
      and marketing expenses
              
              
              1,246
              
              
              
              1,280
              
              
              
              4,994
              
              
              
              4,354Fraud
      loss (recovery) expense
              
              
              (4,028
              )
              
              
              -
              
              
              
              (4,028
              )
              
              
              -FDIC
      insurance fund special assessment
              
              
              4,625
              
              
              
              -
              
              
              
              4,625
              
              
              
              -Other
      operating expenses
              
              
              11,700
              
              
              
              12,393
              
              
              
              47,098
              
              
              
              34,506Total
      non-interest expense
              
              
              52,152
              
              
              
              54,087
              
              
              
              171,497
              
              
              
              156,827Income
      (loss) before income taxes
              
              
              (103,091
              )
              
              
              22,835
              
              
              
              (121,225
              )
              
              
              87,778Income
      tax (benefit) expense
              
              
              (40,000
              )
              
              
              3,607
              
              
              
              (54,386
              )
              
              
              19,743NET
      INCOME (LOSS)
              
              
              (63,091
              )
              
              
              19,228
              
              
              
              (66,839
              )
              
              
              68,035Preferred
      dividends/accretion of preferred discount
              
              
              (2,096
              )
              
              
              -
              
              
              
              (6,245
              )
              
              
              -NET
      INCOME (LOSS) AVAILABLE TO COMMON SHAREHOLDERS
              
              $
              (65,187
              )
              
              $
              19,228
              
              
              $
              (73,084
              )
              
              $
              68,035PER
      SHARE OF COMMON STOCKBasic
      earnings (loss)
              
              $
              (0.63
              )
              
              $
              0.24
              
              
              $
              (0.74
              )
              
              $
              0.91Basic
      earnings (loss) available to common shareholders
              
              $
              (0.65
              )
              
              $
              0.24
              
              
              $
              (0.81
              )
              
              $
              0.91Diluted
      earnings (loss)
              
              $
              (0.63
              )
              
              $
              0.23
              
              
              $
              (0.74
              )
              
              $
              0.90Diluted
      earnings (loss) available to common shareholders
              
              $
              (0.65
              )
              
              $
              0.23
              
              
              $
              (0.81
              )
              
              $
              0.90Dividends
      paid in cash
              
              $
              0.05
              
              
              $
              0.17
              
              
              $
              0.27
              
              
              $
              0.51______________________________________
                The
      accompanying notes are an integral part of these financial
      statements.




4






NATIONAL
PENN BANCSHARES, INC. AND SUBSIDIARIES


UNAUDITED
CONSOLIDATED STATEMENTS OF CHANGES IN SHAREHOLDERS’ EQUITY




(dollars
      in thousands, except share data)
              
              
              
              
              
              
              
              
              
              
              
              
              
              AccumulatedSeries
      B
              
              
              
              
              
              OtherCommon
              
              
              Preferred
              
              
              Retained
              
              
              Comprehensive
              
              
              Treasury
              
              
              
              
              
              ComprehensiveNINE
      MONTHS ENDED SEPTEMBER 30, 2009
              
              Shares
              
              
              Value
              
              
              Stock
              
              
              Earnings
              
              
              Income
      (Loss)
              
              
              Stock
              
              
              Total
              
              
              IncomeBalance
      at December 31, 2008, as previously reported
              
              
              80,731,751
              
              
              $
              1,003,110
              
              
              $
              144,076
              
              
              $
              65,194
              
              
              $
              (32,385
              )
              
              $
              -
              
              
              $
              1,179,995Cumulative
      effect of adoption of FSP FAS 115-2
              
              
              
              
              
              
              
              
              
              
              
              
              
              
              12,407
              
              
              
              (12,407
              )
              
              
              
              
              
              
              -Balance
      at December 31, 2008, as revised
              
              
              80,731,751
              
              
              
              1,003,110
              
              
              
              144,076
              
              
              
              77,601
              
              
              
              (44,792
              )
              
              
              -
              
              
              
              1,179,995Net
      income (loss)
              
              
              -
              
              
              
              
              
              
              
              
              
              
              
              (66,839
              )
              
              
              
              
              
              
              -
              
              
              
              (66,839
              )
              
              $
              (66,839
              )Dividends
      declared Common
              
              
              -
              
              
              
              
              
              
              
              
              
              
              
              (22,086
              )
              
              
              
              
              
              
              -
              
              
              
              (22,086
              )Dividends
      declared and accrued Preferred
              
              
              
              
              
              
              
              
              
              
              
              
              
              
              (5,584
              )
              
              
              
              
              
              
              -
              
              
              
              (5,584
              )Shares
      issued under share-based plans, net of excess tax benefits
              
              
              278,577
              
              
              
              593
              
              
              
              
              
              
              
              -
              
              
              
              
              
              
              
              -
              
              
              
              593Share-based
      compensation
              
              
              -
              
              
              
              896
              
              
              
              
              
              
              
              -
              
              
              
              
              
              
              
              -
              
              
              
              896Shares
      issued from optional cash and dividends reinvested
              
              
              13,943,410
              
              
              
              69,551
              
              
              
              
              
              
              
              
              
              
              
              
              
              
              
              
              
              
              
              69,551Shares
      issued in public offering
              
              
              30,705,000
              
              
              
              153,544
              
              
              
              
              
              
              
              
              
              
              
              
              
              
              
              
              
              
              
              153,544Amortization
      of preferred discount
              
              
              
              
              
              
              (662
              )
              
              
              662
              
              
              
              
              
              
              
              
              
              
              
              
              
              
              
              -Other
      comprehensive income, net of reclassification adjustment and
      taxes
              
              
              
              
              
              
              
              
              
              
              
              
              
              
              
              
              
              
              30,318
              
              
              
              
              
              
              
              30,318
              
              
              
              30,318Other
      comprehensive income adjustment, related to securities for
                which
      other than temporary impairment has been recognized in
                earnings,
      net of tax
              
              
              -
              
              
              
              
              
              
              
              
              
              
              
              
              
              
              
              19,718
              
              
              
              
              
              
              
              19,718
              
              
              
              19,718Total
      comprehensive (loss)
              
              
              -
              
              
              
              -
              
              
              
              
              
              
              
              -
              
              
              
              
              
              
              
              
              
              
              
              -
              
              
              $
              (16,803
              )Balance
      at September 30, 2009
              
              
              125,658,738
              
              
              $
              1,227,032
              
              
              $
              144,738
              
              
              $
              (16,908
              )
              
              $
              5,244
              
              
              $
              -
              
              
              $
              1,360,106Common
              
              
              Preferred
              
              
              Retained
              
              
              Comprehensive
              
              
              Treasury
              
              
              
              
              
              
              ComprehensiveNINE
      MONTHS ENDED SEPTEMBER 30, 2008
              
              Shares
              
              
              Value
              
              
              Stock
              
              
              Earnings
              
              
              Income
      (Loss)
              
              
              Stock
              
              
              Total
              
              
              IncomeBalance
      at December 31, 2007
              
              
              49,068,819
              
              
              $
              491,011
              
              
              $
              0
              
              
              $
              83,130
              
              
              $
              (4,281
              )
              
              
              (8,025
              )
              
              $
              561,835Net
      income
              
              
              -
              
              
              
              -
              
              
              
              -
              
              
              
              68,035
              
              
              
              -
              
              
              
              -
              
              
              
              68,035
              
              
              $
              68,035Dividends
      declared Common
              
              
              -
              
              
              
              -
              
              
              
              -
              
              
              
              (35,874
              )
              
              
              -
              
              
              
              -
              
              
              
              (35,874
              )Shares
      issued under share-based plans, net of excess tax benefits
              
              
              902,059
              
              
              
              5,676
              
              
              
              -
              
              
              
              -
              
              
              
              -
              
              
              
              2766
              
              
              
              8,442Share-based
      compensation
              
              
              -
              
              
              
              1,491
              
              
              
              -
              
              
              
              -
              
              
              
              -
              
              
              
              -
              
              
              
              1,491Shares
      issued for acquisition of:
              
              
              
              
              
              
              
              
              
              
              
              
              
              
              
              
              
              
              
              
              
              
              
              
              
              
              --
      Christiana Bank& Trust Company
              
              
              2,732,813
              
              
              
              43,839
              
              
              
              -
              
              
              
              -
              
              
              
              -
              
              
              
              -
              
              
              
              43,839-
      KNBT Bancorp, Inc.
              
              
              27,205,548
              
              
              
              438,877
              
              
              
              -
              
              
              
              -
              
              
              
              -
              
              
              
              5,623
              
              
              
              444,500Other
      comprehensive (loss), net of reclassification adjustment
                and
      taxes
              
              
              -
              
              
              
              -
              
              
              
              -
              
              
              
              -
              
              
              
              (45,891
              )
              
              
              -
              
              
              
              (45,891
              )
              
              
              (45,891
              )Total
      comprehensive income
              
              
              -
              
              
              
              -
              
              
              
              -
              
              
              
              -
              
              
              
              -
              
              
              
              -
              
              
              
              -
              
              
              $
              22,144Treasury
      shares purchased
              
              
              (22,957
              )
              
              
              -
              
              
              
              -
              
              
              
              -
              
              
              
              -
              
              
              
              (364
              )
              
              
              (364
              )Balance
      at September 30, 2008
              
              
              79,886,282
              
              
              $
              980,894
              
              
              $
              -
              
              
              $
              115,291
              
              
              $
              (50,172
              )
              
              $
              -
              
              
              $
              1,046,013


__ ____________________________________


The
accompanying notes are an integral part of these financial
statements.




5





NATIONAL
PENN BANCSHARES, INC. AND SUBSIDIARIES


UNAUDITED
CONSOLIDATED STATEMENTS OF CASH FLOWS





(Dollars
      in thousands)
              
              Nine
      Months Ended Sept 30,2009
              
              
              2008CASH
      FLOWS FROM OPERATING ACTIVITIESNet
      income (loss)
              
              $
              (66,839
              )
              
              $
              68,035Adjustments
      to reconcile net income to netcash
      provided by operating activities:Provision
      for loan and lease losses
              
              
              107,025
              
              
              
              13,997Share-based
      compensation expense
              
              
              896
              
              
              
              1,491Depreciation
      and amortization
              
              
              13,360
              
              
              
              16,048Deferred
      income tax expense (benefit)
              
              
              (281
              )
              
              
              (1,510
              )Amortization
      (accretion) of premiums and discounts on investmentsecurities,
      net
              
              
              (1,341
              )
              
              
              (1,877
              )Investment
      securities losses (gains), net
              
              
              3,147
              
              
              
              (660
              )Undistributed
      net (earnings) losses of equity-method investments
              
              
              156
              
              
              
              (2,996
              )Loans
      originated for resale
              
              
              (303,257
              )
              
              
              (93,746
              )Proceeds
      from sale of loans
              
              
              302,056
              
              
              
              95,289Gain
      on sale of loans, net
              
              
              (4,473
              )
              
              
              (1,543
              )(Gain)
      loss on sale of other real estate owned, net
              
              
              85
              
              
              
              -Decrease
      in fair value of subordinated debt
              
              
              8,096
              
              
              
              (5,490
              )Loss
      on recognition of impairment on security
              
              
              99,625
              
              
              
              20,000Bank-owned
      life insurance income
              
              
              (3,478
              )
              
              
              (5,124
              )Changes
      in assets and liabilities:Decrease
      (increase)  in accrued interest receivable
              
              
              (1,417
              )
              
              
              (1,822
              )(Decrease)
      Increase  in accrued interest payable
              
              
              (2,699
              )
              
              
              (7,601
              )(Increase)  decrease
      in other assets
              
              
              (11
              )
              
              
              8,373(Decrease)
      in other liabilities
              
              
              (62,382
              )
              
              
              (23,463
              )Net
      cash provided by operating activities
              
              
              88,268
              
              
              
              77,401CASH
      FLOWS FROM INVESTING ACTIVITIESCash
      equivalents received in excess of cash paid for business
      acquired
              
              
              (1,500
              )
              
              
              35,852Proceeds
      from maturities of investment securities held to maturity
              
              
              24,273
              
              
              
              11,145Purchase
      of investment securities held to maturity
              
              
              (124,539
              )
              
              
              -Proceeds
      from sales of investment securities available for sale
              
              
              44,123
              
              
              
              36,245Proceeds
      from maturities of investment securities available for
sale
              
              
              302,882
              
              
              
              266,029Purchase
      of investment securities available for sale
              
              
              (599,988
              )
              
              
              (326,620
              )Net
      increase in loans and leases
              
              
              55,489
              
              
              
              (364,400
              )Purchases
      of premises and equipment
              
              
              (3,046
              )
              
              
              (9,546
              )Proceeds
      from the sale of other real estate owned
              
              
              1,370
              
              
              
              865Proceeds
      from sale of bank building(s)
              
              
              2,550
              
              
              
              636Net
      cash used in investing activities
              
              
              (298,386
              )
              
              
              (349,794
              )CASH
      FLOWS FROM FINANCING ACTIVITIESNet
      increase in interest and non-interestbearing
      demand deposits and savings accounts
              
              
              278,291
              
              
              
              243,658Net  increase
      (decrease) in certificates of deposit
              
              
              130,484
              
              
              
              (27,302
              )Net
      (decrease) increase  in securities sold underagreements
      to repurchase and federal funds purchased
              
              
              (12,194
              )
              
              
              150,849Net
      (decrease) increase in short-term borrowings
              
              
              (3,202
              )
              
              
              98,548Proceeds
      from new long-term borrowings
              
              
              -
              
              
              
              150,000Repayments
      of long-term borrowings
              
              
              (175,438
              )
              
              
              (226,130
              )Shares
      issued under share-based plans
              
              
              629
              
              
              
              2,759Excess
      tax benefits (expense)  on share-based plans
              
              
              (36
              )
              
              
              302Issuance
      of shares under dividend reinvestment and optional cash
              
              
              69,551
              
              
              
              1,336Issuance
      of common stock
              
              
              153,543
              
              
              
              -Purchase
      of Treasury stock
              
              
              -
              
              
              
              (364
              )Cash
      dividends, common
              
              
              (22,086
              )
              
              
              (35,874
              )Cash
      dividends, preferred
              
              
              (5,063
              )
              
              
              -Net
      cash provided by financing activities
              
              
              414,479
              
              
              
              357,782Net
      increase (decrease) in cash and cash equivalents
              
              
              204,360
              
              
              
              85,389Cash
      and cash equivalents at beginning of year
              
              
              195,830
              
              
              
              111,520Cash
      and cash equivalents at end of period
              
              $
              400,191
              
              
              $
              196,909





The
accompanying notes are an integral part of these statements.








6





NOTES TO
UNAUDITED CONSOLIDATED FINANCIAL STATEMENTS





1.  BASIS
OF
PRESENTATION





The accompanying unaudited consolidated
financial statements were prepared in accordance with instructions to Form 10-Q,
and therefore, do not include information or footnotes necessary for a complete
presentation of financial position, results of operations and cash flows in
conformity with accounting principles generally accepted  in the
United States (“GAAP”).  However, all normal, recurring adjustments
that, in the opinion of management, are necessary for a fair presentation of
these financial statements have been included.  These financial
statements should be read in conjunction with the audited consolidated financial
statements and the notes thereto for National Penn Bancshares, Inc. (the
“Company” or “National Penn”)  for the year ended December 31, 2008,
which are included in the Company’s Annual Report on Form 10-K for the year
ended December 31, 2008 (the “Form 10-K”).  The results for the
interim periods presented are not necessarily indicative of the results that may
be expected for the year ending December 31, 2009.





The Company has prepared its
accompanying consolidated financial statements in accordance with GAAP as
applicable to the financial services industry.  Certain amounts in
prior years are reclassified for comparability to the current year’s
presentation.  Such reclassifications, when applicable, have no effect
on net income (loss).  The consolidated financial statements include
the balances of the Company and its wholly owned subsidiaries, including
National Penn Bank (“National Penn Bank”) and Christiana Bank & Trust
Company (“Christiana”).  All material intercompany balances and
transactions have been eliminated in consolidation.  References to the
Company include all the Company’s subsidiaries unless otherwise
noted.





Christiana’s results are included in
the Company’s financial results from the date of acquisition, January 4, 2008.
The Company acquired KNBT Bancorp, Inc. (“KNBT”) on February 1,
2008.  KNBT’s results are included in the Company’s financial results
from the date of acquisition.









7








2.  INVESTMENT
SECURITIES





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




The
      amortized cost, gross unrealized gains and losses, and fair values of the
      Company's investmentsecurities
      are summarized as follows (in thousands):  September
      30, 2009(dollars
      in thousands)
                
                Amortized
                
                
                Gross
      unrealized
                
                
                Gross
      unrealized
                
                
                Faircost
                
                
                gains
                
                
                losses
                
                
                valueAvailable for SaleU.S.
      Treasury securities
                
                $
                145,165
                
                
                $
                115
                
                
                $
                (1
                )
                
                $
                145,279U.S.
      Government agency securities
                
                
                93,240
                
                
                
                365
                
                
                
                -
                
                
                
                93,605State
      and municipal bonds
                
                
                376,602
                
                
                
                14,339
                
                
                
                (3,701
                )
                
                
                387,240Mortgage-backed
      securities
                
                
                886,081
                
                
                
                22,793
                
                
                
                (2,303
                )
                
                
                906,571Trust
      Preferred Pools/Collateralized Debt Obligations
                
                
                3,545
                
                
                
                -
                
                
                
                -
                
                
                
                3,545Marketable
      equity and other securities
                
                
                103,961
                
                
                
                1,633
                
                
                
                (5,811
                )
                
                
                99,783Total
                
                $
                1,608,594
                
                
                $
                39,245
                
                
                $
                (11,816
                )
                
                $
                1,636,023Held to MaturityU.S.
      Treasury securities
                
                $
                355
                
                
                $
                10
                
                
                $
                -
                
                
                $
                365State
      and municipal bonds
                
                
                437,125
                
                
                
                23,177
                
                
                
                (1,050
                )
                
                
                459,252Mortgage-backed
      securities
                
                
                174,734
                
                
                
                1,380
                
                
                
                (333
                )
                
                
                175,781Total
                
                $
                612,214
                
                
                $
                24,567
                
                
                $
                (1,383
                )
                
                $
                635,398December
      31, 2008(dollars
      in thousands)
                
                Amortized
                
                
                Gross
      unrealized
                
                
                Gross
      unrealized
                
                
                Faircost
                
                
                gains
                
                
                losses
                
                
                valueAvailable for SaleU.S.
      Treasury securities
                
                $
                19,999
                
                
                $
                -
                
                
                $
                (2
                )
                
                $
                19,997U.S.
      Government agency securities
                
                
                20,785
                
                
                
                294
                
                
                
                -
                
                
                
                21,079State
      and municipal bonds
                
                
                656,417
                
                
                
                7,412
                
                
                
                (21,168
                )
                
                
                642,661Mortgage-backed
      securities
                
                
                821,462
                
                
                
                14,150
                
                
                
                (10,059
                )
                
                
                825,553Marketable
      equity and other securities
                
                
                87,090
                
                
                
                1,933
                
                
                
                (4,514
                )
                
                
                84,509Total
                
                $
                1,605,753
                
                
                $
                23,789
                
                
                $
                (35,743
                )
                
                $
                1,593,799Held to MaturityU.S.
      Treasury securities
                
                $
                359
                
                
                $
                15
                
                
                $
                -
                
                
                $
                374State
      and municipal bonds
                
                
                185,774
                
                
                
                1,558
                
                
                
                (5,652
                )
                
                
                181,680Mortgage-backed
      securities
                
                
                74,066
                
                
                
                1,565
                
                
                
                (128
                )
                
                
                75,503Trust
      Preferred Pools/Collateralized Debt Obligations
                
                
                65,891
                
                
                
                3,559
                
                
                
                (42,399
                )
                
                
                27,051Total
                
                $
                326,090
                
                
                $
                6,697
                
                
                $
                (48,179
                )
                
                $
                284,608







In 2009 and 2008, all sales of
investments – including bonds with unrealized gains or unrealized losses – are
characterized as portfolio management to accomplish the
following:  reduce credit exposure to a class of assets; rotate out of
a sector; sell lower yielding bonds and re-deploy the proceeds into higher
yielding bonds to take advantage of changing rates at the time of the sale;
improve portfolio yield; or to realize the tax benefit.  The net
effect of these sales was $3.1 million loss year-to-date 2009.





During second quarter 2009 the Company
re-categorized approximately $252 million, in state and municipal bonds from
Available-for-Sale to Held-to-Maturity, in order to mitigate the decrease in
fair value of these long-term securities in a rising rate environment, and the
corresponding decrease to capital. There was no unrealized gain or loss on these
securities at the date of re-categorization.






8






The table below indicates the length of
time individual securities have been in a continuous unrealized loss position at
September 30, 2009:







Less
      than 12 months
              
              
              12
      months or longer
              
              
              TotalNo.
      of
              
              
              Fair
              
              
              Unrealized
              
              
              Fair
              
              
              Unrealized
              
              
              Fair
              
              
              Unrealized(dollars
      in thousands)
              
              Securities
              
              
              Value
              
              
              Losses
              
              
              Value
              
              
              Losses
              
              
              Value
              
              
              LossesU.S.
      Treasury securities
              
              
              1
              
              
              $
              14,938
              
              
              $
              (1
              )
              
              $
              -
              
              
              $
              -
              
              
              $
              14,938
              
              
              $
              (1
              )U.S.
      Government agencies
              
              
              -
              
              
              
              -
              
              
              
              -
              
              
              
              -
              
              
              
              -
              
              
              
              -
              
              
              
              -State
      and municipal bonds
              
              
              113
              
              
              
              4,823
              
              
              
              (301
              )
              
              
              59,963
              
              
              
              (4,134
              )
              
              
              64,786
              
              
              
              (4,435
              )State
      and municipal bonds (taxable)
              
              
              5
              
              
              
              -
              
              
              
              -
              
              
              
              6,189
              
              
              
              (316
              )
              
              
              6,189
              
              
              
              (316
              )Mortgage-backed
      securities/CollateralizedMortgage
      Obligations
              
              
              102
              
              
              
              171,516
              
              
              
              (597
              )
              
              
              53,190
              
              
              
              (2,039
              )
              
              
              224,706
              
              
              
              (2,636
              )Total
      debt securities
              
              
              221
              
              
              
              191,277
              
              
              
              (899
              )
              
              
              119,342
              
              
              
              (6,489
              )
              
              
              310,619
              
              
              
              (7,388
              )Marketable
      equity securities
              
              
              30
              
              
              
              3,611
              
              
              
              (1,571
              )
              
              
              7,175
              
              
              
              (4,240
              )
              
              
              10,786
              
              
              
              (5,811
              )Total
              
              
              251
              
              
              $
              194,888
              
              
              $
              (2,470
              )
              
              $
              126,517
              
              
              $
              (10,729
              )
              
              $
              321,405
              
              
              $
              (13,199
              )The
      table below indicates the length of time individual securities have been
      in a continuous unrealized loss position at December 31,
    2008.Less
      than 12 months
              
              
              12
      months or longer
              
              
              TotalNo.
      of
              
              
              Fair
              
              
              Unrealized
              
              
              Fair
              
              
              Unrealized
              
              
              Fair
              
              
              Unrealized(dollars
      in thousands)
              
              Securities
              
              
              Value
              
              
              Losses
              
              
              Value
              
              
              Losses
              
              
              Value
              
              
              LossesU.
      S. Treasury securities
              
              
              3
              
              
              $
              19,997
              
              
              $
              (2
              )
              
              $
              -
              
              
              $
              -
              
              
              $
              19,997
              
              
              $
              (2
              )State
      and municipal bonds
              
              
              687
              
              
              
              385,739
              
              
              
              (20,229
              )
              
              
              40,251
              
              
              
              (5,617
              )
              
              
              425,990
              
              
              
              (25,846
              )State
      and municipal bonds (taxable)
              
              
              12
              
              
              
              13,888
              
              
              
              (974
              )
              
              
              -
              
              
              
              -
              
              
              
              13,888
              
              
              
              (974
              )Mortgage-backed
      securities/CollateralizedMortgage
      Obligations
              
              
              140
              
              
              
              206,437
              
              
              
              (10,141
              )
              
              
              2,628
              
              
              
              (46
              )
              
              
              209,065
              
              
              
              (10,187
              )Trust
      Preferred Pools/CollateralizedDebt
      Obligations
              
              
              22
              
              
              
              10,627
              
              
              
              (14,028
              )
              
              
              11,211
              
              
              
              (28,371
              )
              
              
              21,838
              
              
              
              (42,399
              )Total
      debt securities
              
              
              864
              
              
              
              636,688
              
              
              
              (45,374
              )
              
              
              54,090
              
              
              
              (34,034
              )
              
              
              690,778
              
              
              
              (79,408
              )Marketable
      equity securities
              
              
              26
              
              
              
              6,005
              
              
              
              (1,035
              )
              
              
              4,899
              
              
              
              (3,479
              )
              
              
              10,904
              
              
              
              (4,514
              )Total
              
              
              890
              
              
              $
              642,693
              
              
              $
              (46,409
              )
              
              $
              58,989
              
              
              $
              (37,513
              )
              
              $
              701,682
              
              
              $
              (83,922
              )





The Company reviews investment debt
securities on an ongoing basis for the presence of other than temporary
impairment (“OTTI”).  OTTI losses on individual investment securities
were recognized during the first and second quarters 2009.  The new
guidance requires that credit-related OTTI be recognized in earnings while
noncredit-related OTTI on securities not expected to be sold is recognized in
accumulated other comprehensive income (loss) (“OCI”).  In addition,
the new guidance requires the reclassification of the noncredit-related portion
of OTTI losses previously recognized in prior quarters from retained earnings to
OCI.





As of September 30, 2009, the Company
no longer has the intent to hold its portfolio of trust preferred CDO’s to
maturity, due to the deteriorating performance of the underlying
collateral.  The securities were re-categorized from Held-to-Maturity
to Available-for-Sale as of September 30, 2009.  As a result of this
change in intent, the Company recorded an OTTI charge equal to the difference
between book and market value of these securities to current earnings through
the income statement.  This resulted in a pre-tax impairment charge of
$84.7 million and $99.6 million for the three and nine months ending September
30, 2009, respectively.   After these write-downs, the book value
of the entire pooled trust preferred investments is now approximately $3.5
million.  For the three and nine months ended September 30, 2008, the
Company recorded a $20.0 million pretax other-than-temporary impairment charge
on the Company’s entire investment in its sole synthetic CDO.






9




The table
below presents information pertaining to the non-credit impairment portion of
OCI as of September 30, 2009:




(dollars
      in thousands)
              
              Non
      credit-relatedOTTIBeginning
      Balance December 31, 2008
              $
              19,087Additions
              
              27,043Reductions
              
              (46,130)Ending
      Balance September 30, 2009
              $
              -







The
following table represents a rollforward of the activity related to the credit
loss component recognized in earnings on debt securities held by the Company for
which a portion of other-than-temporary impairment was recognized in other
comprehensive income.





(dollars
      in thousands)
              
              Three
      months endedSeptember
      30, 2009Beginning
      balance, July 1, 2009
              
              $
              (14,921
              )Additions
      to OTTI securities where nocredit
      losses were recognized prior toJuly
      1, 2009
              
              
              -Additions
      to OTTI securities where creditlosses
      have been recognized afterJuly
      1, 2009
              
              
              (84,704
              )Ending
      balance, September 30, 2009
              
              $
              (99,625
              )





3.  LOANS





The Company identifies 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 balance
of impaired and restructured loans was $117.0 million on September 30,
2009.  The total balance of impaired loans with a specific valuation
allowance at September
30, 2009 was $34.3 million.  The specific valuation allowance
allocated to these impaired loans was $13.1 million.  The total
balance of impaired loans without a specific valuation allowance was $82.7
million.





The balance of impaired and
restructured loans was $32.6 million at December 31, 2008.  The total
balance of impaired loans with a valuation allowance at December 31, 2008 was
$11.4 million.  The specific valuation allowance allocated to these
impaired loans was $5.1 million.  The total balance of impaired loans
without a specific valuation allowance at   December 31, 2008 was
$21.2 million.





The Company may recognize income on
impaired loans on a cash basis when the loans are both current and the
collateral on the loan is sufficient to cover the outstanding obligation to the
Company.  If these factors do not exist, the Company will not
recognize income on such loans.





4.  SHAREHOLDERS’
EQUITY





Cash
Dividends
 
 On October 27, 2009, the Company’s
Board of Directors declared a cash dividend of $.01 per share payable on
November 17, 2009 to shareholders of record on November 8, 2009.
 
 On October 27, 2009, the Company’s
Board of Directors declared a cash dividend in the total amount of $1,875,000
(being 5% times
$150,000,000 times 25% or $12.50
per share) on the 150,000 shares of Series B Preferred Stock issued, outstanding
and held by the United States Department of the Treasury, as sole shareholder of
record as of November 1, 2009, with such dividend payable on November 16,
2009.
 
 On July 22, 2009, the Company’s Board
of Directors declared a cash dividend of $.05 per share payable on August 17,
2009 to shareholders of record on August 1, 2009.
 
 On July 22, 2009, the Company’s Board
of Directors declared a cash dividend in the total amount of $1,875,000 (being
5% times
$150,000,000 times 25% or $12.50
per share) on the 150,000 shares of Series B Preferred Stock issued, outstanding
and held by the United States Department of the Treasury, as sole shareholder of
record as of August 1, 2009, with such dividend payable on August 17,
2009.




10


On April
21, 2009, the Company’s Board of Directors declared a cash dividend of $.05 per
share payable on May 15, 2009 to shareholders of record on May 1,
2009.
 
 On April
21, 2009, the Company’s shareholders approved an amendment to the Company’s
articles of incorporation to increase the number of shares of authorized common
stock from 100 million to 250 million.
 
 On April 21, 2009, the Company’s Board of Directors
declared a cash dividend in the total amount of $1,875,000.00 (being 5%
times
$150,000,000 times 25% or $12.50
per share) on the 150,000 shares of Series B Preferred Stock issued, outstanding
and held by the United States Department of the Treasury, being sole shareholder
of record as of May 1, 2009, with such dividend payable on May 15,
2009.
  On
January 28, 2009, the Company’s Board of Directors declared a cash dividend of
$.17 per share payable on February 17, 2009 to shareholders of record on
February 7, 2009.
 
 Dividend Reinvestment and
Stock Purchase Plan
 
 In April
2009, the Company amended the Company's Dividend Reinvestment and Stock Purchase
Plan (the “DRP”) extending the 10% discount on reinvested dividends and new
shares purchased under the DRP until the earlier of the date on which a total of
$75 million in voluntary cash contributions were received or December 31, 2009.
The amendment also provided that voluntary cash contributions could, as of April
21, 2009, be made in amounts up to $250,000 per month, an increase from the
prior monthly limitation of $50,000.  During 2009, $69.6 million was
raised under the Company’s DRP.  Approximately $73.9 million in
capital was raised through the DRP since originally enhanced in November
2008.
 
 On June
12, 2009, the Company terminated the 10% discount for voluntary cash
contributions and the $250,000 monthly maximum limit on voluntary cash
contributions under the DRP.  Beginning on June 18, 2009, the Company
accepted monthly voluntary cash contributions in amounts not to exceed $10,000
each for investment under the DRP on or about the 17th day
of the following month, at a purchase price equal to the fair market value of
the Company’s common stock on the investment date.
 
 Underwritten Public
Offering
 
 On
September 15, 2009, the Company completed an underwritten public offering of its
common stock and $153.5 million in capital was raised.  26,700,000
shares were issued at a price of $5.25 per share.  On September 18,
2009, an additional 4,005,000 shares were issued at $5.25 per share pursuant to
the underwriters’ exercise of their over-allotment option to purchase such
additional shares.
 
 TARP Capital Purchase
Program
 
 During
2008, the Company completed the sale of its senior preferred stock totaling
$150.0 million to the U.S. Department of the Treasury under its TARP Capital
Purchase Program.  In the transaction, the U.S. Treasury purchased
150,000 shares of newly issued, non-voting National Penn senior preferred stock
with an aggregate liquidation preference of $150 million and an initial annual
dividend of 5%. U.S. Treasury also received warrants to purchase 1,470,588
shares of National Penn common stock at an exercise price of $15.30 per
share.  On October 26, 2009, the number of warrants outstanding was
reduced to 735,294 as the result of the Company’s September 2009 public offering
of common stock.
 
 Stock
Repurchases
 
 The
Company’s Board of Directors previously authorized the repurchase of up to
2,121,800 shares of the Company’s common stock to be used to fund the Company’s
DRP, share compensation plans, share-based benefit plans, and employee stock
purchase plan.  No shares have been repurchased since second quarter
2008 because the Company has discontinued opportunistic repurchases of blocks of
National Penn stock as well as discontinued its daily de minimis stock
repurchases.  These actions were taken in light of the current
economic environment and have helped to preserve the Company’s capital
ratios.  Under the terms of the TARP Capital Purchase Program,
repurchases of shares of its common stock by the Company are also
restricted.


11





5.  EARNINGS
PER SHARE





The components of the Company’s basic
and diluted earnings per share are as follows:




Three
      Months Ended September 30,2009
              
              
              2008Net
              
              
              Average
              
              
              
              
              
              Net
              
              
              Average(dollars
      in thousands,
              
              Loss
              
              
              Shares
              
              
              Per
      Share
              
              
              Income
              
              
              Shares
              
              
              Per
      Shareexcept
      per share data)
              
              (numerator)
              
              
              (denominator)
              
              
              Amount
              
              
              (numerator)
              
              
              (denominator)
              
              
              AmountBasic
      earnings per shareNet
      income (loss)
              
              $
              (63,091
              )
              
              
              100,064
              
              
              $
              (0.63
              )
              
              $
              19,228
              
              
              
              79,742
              
              
              $
              0.24Preferred
      stock dividendsand
      accretion of discount
              
              
              (2,096
              )
              
              
              
              
              
              
              (0.02
              )
              
              
              -
              
              
              
              -
              
              
              
              -Net
      income (loss) availableto
      common shareholders
              
              
              (65,187
              )
              
              
              100,064
              
              
              
              (0.65
              )
              
              
              19,228
              
              
              
              79,742
              
              
              
              0.24Diluted
      earnings per shareEffect
      of dilutive securities:Options
              
              
              
              
              
              
              -
              
              
              
              -
              
              
              
              
              
              
              
              754
              
              
              
              (0.01
              )Net
      income (loss)available tocommon
      shareholdersplus
      assumed conversions
              
              $
              (65,187
              )
              
              
              100,064
              
              
              $
              (0.65
              )
              
              $
              19,228
              
              
              
              80,496
              
              
              $
              0.23Year-to-Date
      September 30,2009
              
              
              2008Net
              
              
              Average
              
              
              
              
              
              
              Net
              
              
              Average(dollars
      in thousands,
              
              Loss
              
              
              Shares
              
              
              Per
      Share
              
              
              Income
              
              
              Shares
              
              
              Per
      Shareexcept
      per share data)
              
              (numerator)
              
              
              (denominator)
              
              
              Amount
              
              
              (numerator)
              
              
              (denominator)
              
              
              AmountBasic
      earnings per shareNet
      income (loss)
              
              $
              (66,839
              )
              
              
              89,760
              
              
              $
              (0.74
              )
              
              $
              68,035
              
              
              
              74,834
              
              
              $
              0.91Preferred
      stock dividendsand
      accretion of discount
              
              
              (6,245
              )
              
              
              -
              
              
              
              (0.07
              )
              
              
              -
              
              
              
              -
              
              
              
              -Net
      income (loss) availableto
      common shareholders
              
              
              (73,084
              )
              
              
              89,760
              
              
              
              (0.81
              )
              
              
              68,035
              
              
              
              74,834
              
              
              
              0.91Diluted
      earnings per shareEffect
      of dilutive securities:Options
              
              
              
              
              
              
              -
              
              
              
              -
              
              
              
              
              
              
              
              637
              
              
              
              (0.01
              )Net
      income (loss)available tocommon
      shareholders plusassumed
      conversions
              
              $
              (73,084
              )
              
              
              89,760
              
              
              $
              (0.81
              )
              
              $
              68,035
              
              
              
              75,471
              
              
              $
              0.90


Stock option and restricted shares were
not included in the computation of diluted earnings per share because the result
of doing so for the three and nine months ended September 30, 2009 is
anti-dilutive.





For the three months ended September
30, 2008, restricted shares totaling 55,493 with an average grant price of
$16.71 per share and options to purchase shares of common stock totaling
3,988,508 with grant prices ranging from $14.48 to $21.49 per share were
outstanding, but not used in computing the effect of dilutive securities because
the option exercise price was greater than the average market
price.  For the nine months ended September 30, 2008, restricted
shares totaling 54,193 with an average grant price of $16.71 per share and
options to purchase shares of common stock totaling 3,541,751 with grant prices
ranging from $14.48 to $21.49 were outstanding.





6.  SEGMENT
REPORTING





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 Chief Executive
Officer.  The Company has applied the aggregation criteria set forth
in Accounting Standards Codification (“ASC”) 280 for its National Penn operating
segments to create one reportable segment, “Community Banking.”






12





The Company’s community banking segment
consists of commercial and retail banking.  The community banking
business segment is managed as a single strategic unit, which generates revenue
from a variety of products and services provided by National Penn Bank and
Christiana.  For example, commercial lending is dependent upon the
ability of National Penn Bank and Christiana to fund themselves 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 are components of the Company which engage in
business activities which earn revenues and generate expenses and for which
operating results are reviewed by the Company’s chief operating decision maker
for purposes of making decisions with regard to resource allocation and
performance evaluation.  Individually, however, none of the operating
segments meet the quantitative criteria set forth in the FASB guidance on
segment reporting.  A combination of operating segments with similar
economic characteristics is evaluated in each interim and annual reporting
period to determine whether any or a combination of operating segments meets the
criteria for a reportable segment.  These characteristics include: the
nature of products and services; the nature of their business processes; the
types of customers; distribution methods; and the nature of the regulatory
environment.  As a result of the qualitative assessment and the
quantitative criteria, these operating segments have been determined to be
non-reportable and are presented in the aggregate with the description
“Other”.





These non-reportable segments include
wealth management, insurance, leasing, and the Parent and are included in the
“Other” category.  These operating segments within the Company’s
operations do not have similar characteristics to the community banking
operations and do not individually or in the aggregate meet the quantitative or
qualitative thresholds requiring separate disclosure.  The operating
segments in the “Other” category earn revenues primarily through the generation
of fee income and are also aggregated based on their similar economic
characteristics, products and services, type or class of customer, methods used
to distribute products and services and/or nature of their regulatory
environment.  The identified segments reflect the manner in which
financial information is currently evaluated by management.





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.





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





As
      of and for the Nine Months EndedSeptember
      30, 2009Community(dollars
      in thousands)
              
              Banking
              
              
              Other
              
              
              ConsolidatedTotal
      assets
              
              $
              9,654,675
              
              
              $
              85,635
              
              
              $
              9,740,310Total
      deposits
              
              
              6,798,662
              
              
              
              -
              
              
              
              6,798,662Net
      interest income (loss)
              
              
              189,986
              
              
              
              (5,282
              )
              
              
              184,704Total
      non-interest income (loss)
              
              
              (53,917
              )
              
              
              26,510
              
              
              
              (27,407
              )Total
      non-interest expense
              
              
              (142,323
              )
              
              
              (29,174
              )
              
              
              (171,497
              )Net
      income (loss)
              
              
              (61,118
              )
              
              
              (5,721
              )
              
              
              (66,839
              )As
      of and for the Nine Months EndedSeptember
      30, 2008Community(dollars
      in thousands)
              
              Banking
              
              
              Other
              
              
              ConsolidatedTotal
      assets
              
              $
              9,240,770
              
              
              $
              76,025
              
              
              $
              9,316,795Total
      deposits
              
              
              6,220,643
              
              
              
              -
              
              
              
              6,220,643Net
      interest income (loss)
              
              
              193,028
              
              
              
              (3,388
              )
              
              
              189,640Total
      non-interest income
              
              
              31,066
              
              
              
              37,896
              
              
              
              68,962Total
      non-interest expense
              
              
              129,420
              
              
              
              27,407
              
              
              
              156,827Net
      income (loss)
              
              
              63,728
              
              
              
              4,307
              
              
              
              68,035





13





7.    SHARE-BASED
COMPENSATION





At September 30, 2009, the Company had
certain compensation plans authorizing the Company to grant various share-based
employee and non-employee director awards, including common stock, options,
restricted stock, restricted stock units and other stock-based awards
(collectively, “Plans”).   The Company accounts for these Plans
in accordance with ASC 718.





A total of 5.3 million shares of common
stock have been made available for awards to be granted under these Plans
through November 30, 2014.  As of September 30, 2009, 3.1 million of
these shares remain available for issuance.  The Company has 184,423
awards expiring during the next twelve months ending September 30,
2010.




Share-based compensation expense is
included in salaries, wages and employee benefits expense in the unaudited
Consolidated Statements of Income in this Report.  Share-based
compensation expense of $437,000 and $446,000, and a related income tax benefit
of $153,000 and $156,000 were recognized for the three months
ended  September 30, 2009 and 2008,
respectively.  Share-based compensation expense of $896,000 and $1.5
million, and a related income tax benefit of $314,000 and $522,000 were
recognized for the nine months ended September 30, 2009 and 2008,
respectively.  Total cash received during the nine months ended
September 30, 2009 for activity under the Plans was $629,000.





The total intrinsic value (market value
on the date of exercise less the grant price) of stock options exercised during
the nine months ended September 30, 2009 and 2008 was $466,000 and $7.1 million,
respectively.  The tax benefit recognized for option exercises during
the nine months ended September 30, 2009 and 2008 totaled $106,000 and $2.3
million, respectively.




As of September 30, 2009, there was
approximately $784,000 of total unrecognized compensation cost related to
unvested stock options; that cost is expected to be recognized over a
weighted-average period of less than five years.





8.  RETIREMENT
PLANS





The Company has a non-contributory
defined benefit pension plan covering substantially all employees of the Company
and its subsidiaries as of September 30, 2009.  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.





Net periodic defined benefit pension
expense for the six months ended September 30, 2009 and 2008 included the
following components:




Nine
      Months Ended Sept 30,2009
              
              
              2008Service
      cost
              
              $
              2,155,004
              
              
              $
              1,255,005Interest
      cost
              
              
              1,553,983
              
              
              
              1,367,274Expected
      return on plan assets
              
              
              (1,776,121
              )
              
              
              (2,065,239
              )Amortization
      of prior service cost
              
              
              (386,876
              )
              
              
              (386,877
              )Amortization
      of unrecognized net actual loss
              
              
              1,061,989
              
              
              
              167,199Net
      periodic benefit cost
              
              $
              2,607,979
              
              
              $
              337,362





The
expected contribution to the pension plan for plan year 2009 is approximately
$1.5 million, of which $1.1 million was recorded in the nine months ended
September 30, 2009.





Employees
from the KNBT merger participated in multi-employer defined benefit pension
plans, both of which were frozen prior to the acquisition.These plans
were terminated in the first quarter 2009 with no impact to current
earnings.





9.  RECENT
ACCOUNTING PRONOUNCEMENTS





Accounting
Standards Codification




The FASB
issued Account Standards Update (“ASU”) 2009-01, Amendments
based on Statement of Financial Accounting Standards No. 168—TheFASB
Accounting Standards Codification and
the Hierarchy of Generally Accepted Accounting Principles, in June 2009
to codify in ASC 105, Generally
Accepted Accounting Principles, FASB Statement 168, TheFASB Accounting Standards Codification and
the Hierarchy of Generally Accepted Accounting Principles, which was
issued to establish the Codification as the sole source of authoritative U.S.
GAAP recognized by the FASB, excluding SEC guidance, to be applied by
nongovernmental entities. The guidance in ASC 105 is effective for financial
statements issued for interim and annual periods ending after September 15,
2009. Applying the guidance in ASC 105 did not impact the Company’s financial
condition and results of operations. The Company has revised its references to
pre-Codification GAAP in its financial statements for the three and nine month
periods ended September 30, 2009.






14




Variable
Interest Entities




In
June 2009, the Financial Accounting Standards Board issued FASB Statement
167, Amendments
to FASB Interpretation No. 46(R),to
improve how enterprises account for and disclose their involvement with variable
interest entities (“VIE”), which are special-purpose entities, and other
entities whose equity at risk is insufficient or lack certain characteristics.
Among other things, Statement 167 changes how an entity determines whether it is
the primary beneficiary of a variable interest entity (VIE) and whether that VIE
should be consolidated. The new Statement requires an entity to provide
significantly more disclosures about its involvement with VIEs. As a result, the
Company must comprehensively review its involvements with VIEs and potential
VIEs, including entities previous considered to be qualifying special purpose
entities, to determine the effect on its consolidated financial statements and
related disclosures. Statement
167 is effective as of the beginning of a reporting entity’s first annual
reporting period that begins after November 15, 2009 and for interim
periods within the first annual reporting period. Earlier application is
prohibited. The
Company is in the process of evaluating the impact Statement 167 will have on
its consolidated financial statements.




Transfers
of Financial Assets




In
June 2009, the Financial Accounting Standards Board issued FASB Statement
166, Accounting
for Transfers of Financial Assets: an Amendment of FASB Statement No. 140.Statement 166 changes the derecognition guidance for transferors of
financial assets, including entities that sponsor securitizations, to align that
guidance with the original intent of FASB Statement 140, Accounting
for the Transfers and Servicing of Financial Assets and Extinguishments of
Liabilities. Statement 166 also eliminates the exemption from
consolidation for qualifying special-purpose entities (“QSPE”). As a result, all
existing QSPEs need to be evaluated to determine whether the QSPE should be
consolidated in accordance with Statement 166. Statement
166 is effective as of the beginning of a reporting entity’s first annual
reporting period beginning after November 15, 2009, for interim periods
within that first annual reporting period, and for interim and annual reporting
periods thereafter. The recognition and measurement provisions of Statement 166
must be applied to transfers that occur on or after the effective date. Early
application is prohibited. The new
Statement also requires additional disclosures about transfers of financial
assets that occur both before and after the effective date. The
Company does not believe that the adoption of Statement 166 will have a
significant effect on its financial statements.




Subsequent
Events




Effective
June 30, 2009 the Company adopted new accounting guidance introduces new
terminology, defines a date through which management must evaluate subsequent
events, and lists the circumstances under which an entity must recognize and
disclose events or transactions occurring after the balance-sheet date. The
Company evaluated its September 30, 2009 financial statements for
subsequent events through November 9, 2009, the date the financial statements
were available to be issued. The Company is not aware of any other subsequent
events which would require recognition or disclosure in the financial
statements, other than the additional contribution of capital which was made to
the Company’s banking subsidiary, National Penn Bank.  As described in
Part I, Item 2 in this Report,on
October 27, 2009 the Company’s board of directors approved an additional capital
contribution of $60 million to National Penn Bank improving each of the
regulatory capital ratios.





Interim disclosures about
fair value of financial instruments





On April
9, 2009, the FASB Interim
Disclosures about Fair Value of Financial Instruments, which increases
the frequency of required disclosures about fair value to include interim
reporting periods as well as annual financial statements.  The
guidance is effective for interim reporting periods ending after June 15, 2009,
but does not require disclosures for earlier periods presented for comparative
purposes at initial adoption.  In periods after initial adoption, this
guidance requires comparative disclosures only for periods ending after initial
adoption. The Company incorporated this guidance in its financial statements
beginning with the period ended March 31, 2009, without a material
impact.






15


Other-Than-Temporary
Impairment




The
Company early adopted guidance on other-than-temporary impairments of debt
securities to improve the financial statement disclosures and clarify the
interaction of the factors that should be considered when determining whether a
debt security is other-than-temporarily impaired.




To
evaluate whether a debt security is other-than-temporarily impaired, an entity
must first determine whether the fair value of the debt security is less than
its amortized cost basis at the balance sheet date. If the fair value is less
than the amortized cost basis, then the entity must assess whether it intends to
sell the security or whether it is more likely than not that it will be required
to sell the debt security before recovery of its amortized cost basis. If an
entity determines that it will sell a debt security or that it more likely than
not will be required to sell a debt security before recovery of its amortized
cost basis, then it must recognize the difference between the fair value and the
amortized cost basis of the debt security in earnings. Otherwise, the
other-than-temporary impairment must be separated into two components: the
amount related to the credit loss and the amount related to all other factors.
The amount related to the credit loss must be recognized in earnings, while the
other component must be recognized in other comprehensive income, net of tax.
The portion of other-than-temporary impairment recognized in earnings would
decrease the amortized cost basis of the debt security, and subsequent
recoveries in the fair value of the debt security would not result in a write-up
of the amortized cost basis.




The
Company adopted this guidance effective January 1, 2009. As a result of early
adopting, the Company recorded a cumulative effect adjustment to increase the
opening balance of retained earnings by $19.1 million, pretax ($12.4 million
after-tax) and a corresponding decrease to accumulated other comprehensive
income. The additional disclosures related to our adoption of this guidance are
included in Note 2 – Investment Securities.





Determining Fair Value of
Liabilities





In August
2009, the FASB issued Accounting Standards Update (“ASU”) 2009-05, Measuring Liabilities at Fair
Value, to amend FASB
Accounting Standards Codification (“ASC”) 820, Fair Value Measurements and
Disclosures, to clarify how entities should estimate the fair value of
liabilities.  ASC 820, as amended, includes clarifying guidance for
circumstances in which a quoted price in an active market is not available, the
effect of the existence of liability transfer restrictions, and the effect of
quoted prices for the identical liability, including when the identical
liability is traded as an asset. The amended guidance in ASC 820 on measuring
liabilities at fair value is effective for the first interim or annual reporting
period beginning after August 28, 2009, with earlier application
permitted. The
Company is in the process of evaluating the impact the amended guidance in ASC
820 will have on its consolidated financial statements.




Determining Fair Value in an
Inactive Market




The
Company early adopted guidance to which improves the process for estimating fair
value when the volume and level of activity for an asset or liability have
significantly decreased and on identifying circumstances that indicate a
transaction is not orderly. The new guidance emphasizes that, regardless of
whether the volume and level of activity for an asset or liability have
decreased significantly and regardless of which valuation technique was used,
the objective of a fair value measurement remains the same—to estimate the price
that would be received to sell an asset or transfer a liability in an orderly
transaction between market participants at the measurement date under current
market conditions.




Effective
January 1, 2009 the Company early adopted this guidance. The adoption did
not have a material impact on the Company’s financial condition and results of
operations. The additional disclosures related to our adoption of this guidance
are included in Note 12 – Fair Values of Financial Instruments.




16




Disclosures about Derivative
Instruments and Hedging Activities





In March
2008, the FASB issued Disclosures about Derivative
Instruments and Hedging Activities.  The guidance requires
enhanced disclosures about an entity’s derivative and hedging activities,
specifically, how and why an entity uses derivative instruments; how derivative
instruments and related hedged items are accounted for under prior guidance and
its related interpretations; how derivative instruments and related hedged items
affect an entity’s financial position, financial performance, and cash
flows.  This guidance is effective for all entities for fiscal years
and interim periods beginning after November 15, 2008.  The Company’s
adoption of this guidance did not have a significant impact on its consolidated
financial statements.





10.
LITIGATION




As
previously reported, National Penn's financial results for the fourth
quarter 2008 included a special charge of $4.5 million for losses attributable
to a fraud scheme involving employee loan accounting irregularities. National
Penn continues reviewing, and strengthening where necessary, its internal
control procedures. (See Part I, Item 4 of this Report.) On September 30, 2009,
National Penn recognized a net recovery of $4.0 million from its insurance
carrier in settlement of the Company’s insurance claim.  National Penn
is continuing to participate in the civil recovery efforts and is
cooperating with law enforcement authorities in their
investigation.




Various other actions and proceedings
are currently pending to which National Penn or one or more of its subsidiaries
is a party. These actions and proceedings arise out of routine operations and,
in management's opinion, are not expected to have a material impact on National
Penn's financial position or results of operations.




11.  DERIVATIVE
FINANCIAL INSTRUMENTS





The Company uses interest rate swaps
(“swaps”) to manage its interest rate risk as well as to facilitate customer
transactions and meet their financing needs.  These swaps qualify as
derivatives, but are not designated as hedging instruments.  The
Company had fair value commercial loan swaps with an aggregate notional amount
of $545.1 million at September 30, 2009.  The fair value of the swaps
is included in other assets and other liabilities and the change in fair value
is recorded in current earnings as other income or other expense.  The
Company’s swaps are marked-to-market quarterly.  At inception, the
Company did not exchange any cash to enter into these swaps and therefore, no
initial investment was recognized.





Swap contracts involve the risk of
dealing with counterparties and their ability to meet contractual
terms.  When the fair value of a derivative instrument contract is
positive, this generally indicates that the counterparty or customer owes the
Company, and results in credit risk to the Company.  When the fair
value of a derivative instrument contract is negative, the Company owes the
customer or counterparty and therefore, has no credit risk.  The net
amount receivable (payable) at September 30, 2009 and December 31, 2008 for the
commercial loan swaps was $0.





The Company’s credit exposure on
interest rate swaps is limited to the Company’s net favorable value and interest
payments of all swaps from each counterparty.  The Company minimizes
the credit risk in derivative instruments by


including
derivative credit risk in its credit underwriting procedures, and by entering
into transactions with high-quality counterparties that are reviewed
periodically by the Company’s treasury function.   At September
30, 2009, the Company’s credit exposure for derivatives to facilitate loan
transactions totaled $21.5 million.  Of that exposure, $4.3 million
was associated with hedges of criticized and classified loans.





In October 2008, the Company entered
into interest rate swap contracts to modify the interest rate characteristics of
designated subordinated debt instruments from variable to fixed in order to
reduce the impact of changes in future cash flows due to interest rate
changes.  The Company hedged its exposure to the variability of future
cash flows for all forecasted transactions for a maximum of three years for
hedges converting $75.0 million of floating-rate subordinated debt to
fixed.  The fair value of these derivatives, totaling a $3.0 million
liability at September 30, 2009, is reported in other assets or other
liabilities and offset in accumulated other comprehensive income (loss) for the
effective portion of the derivatives.  Ineffectiveness of these swaps,
if any, is recognized immediately in earnings.  The ineffective
portion and the change in value of these derivatives resulted in no adjustment
to current earnings for 2009.







17











A summary of the Company’s interest
rate swaps is included in the following table:




As
      of September 30, 2009
              
              
              As
      of December 31, 2008Estimated
              
              
              Weighted-Average
              
              
              
              
              
              
              
              EstimatedNotional
              
              
              Fair
              
              
              Years
      to
              
              
              Receive
              
              
              Pay
              
              
              Notional
              
              
              Fair(dollars
      in thousands)
              
              Amount
              
              
              Value
              
              
              Maturity
              
              
              Rate
              
              
              Rate
              
              
              Amount
              
              
              ValueInterest
      rate swap agreements:Swap
      on trust preferred borrowing
              
              $
              75,000
              
              
              $
              (3,037
              )
              
              
              2.08
              
              
              
              0.47
              %
              
              
              3.26
              %
              
              $
              75,000
              
              
              $
              (3,238
              )Asset
      Commercial Loan swaps
              
              
              272,568
              
              
              $
              (21,473
              )
              
              
              5.27
              
              
              
              1.92
              %
              
              
              6.11
              %
              
              
              332,600
              
              
              $
              (30,124
              )Liability
      Commercial Loan swaps
              
              
              272,568
              
              
              
              21,473
              
              
              
              5.27
              
              
              
              6.11
              %
              
              
              1.92
              %
              
              
              257,601
              
              
              
              30,124Total
      swaps
              
              $
              620,136
              
              
              $
              (3,037
              )
              
              
              4.88
              
              
              
              3.59
              %
              
              
              3.92
              %
              
              $
              665,201
              
              
              $
              (3,238
              )


12.  FAIR
VALUE MEASUREMENT AND FAIR VALUE OF FINANCIAL INSTRUMENTS





The Company early adopted ASC 825 as of
January 1, 2007 and elected the fair value option for the Company’s only fixed
rate subordinated debt liability with a cost basis of $65.2 million, which is a
fixed rate subordinated debenture relating to its retail offering to individual
consumers and investors of trust preferred securities under the Company’s
Capital Trust II.  The Company has no other similar subordinated
debentures, as the subordinated debentures remaining are variable rate financial
instruments supporting variable rate trust preferred securities issued to
institutional investors on a pooled basis.





The fair value as of September 30, 2009
was $58.8 million based on an unadjusted quoted price in an active
market.  Other operating income includes a loss of $8.1 million and a
gain of $5.5 million for the change in fair value of the subordinated debt for
the nine months ended September 30, 2009 and 2008, respectively.





This
subordinated debt has a fixed rate of 7.85% and a maturity date of September 30,
2032 with a call provision after September 30,
2007.    Since its origination, changing asset structures
have led to shorter maturity and duration assets that in today’s environment no
longer match up well with a long duration liability.  Fair valuing
this liability will provide the restructuring flexibility to better match
shorter duration assets with more comparable liabilities.  The Company
evaluates its funding sources on a periodic basis to maximize its interest rate
risk management effectiveness.  The Company considers the fair value
option a mechanism to match its assets and liabilities and will consider it for
similar liabilities in the future.





Simultaneously with the adoption of ASC
825, the Company early adopted ASC 820, “Fair Value Measurements and
Disclosures”, effective January 1, 2007.   This guidance
clarifies that fair value is an exit price, representing the amount that would
be received to sell an asset or paid to transfer a liability in an orderly
transaction between market participants. Fair value measurements are not
adjusted for transaction costs. It also establishes a fair value hierarchy that
prioritizes the inputs to valuation techniques used to measure fair value. The
hierarchy gives the highest priority to unadjusted quoted prices in active
markets for identical assets or liabilities (Level 1 measurements) and the
lowest priority to unobservable inputs (Level 3 measurements). The three levels
of the fair value hierarchy under ASC 820 are described below:





Basis of
Fair Value Measurement:





Level 1 - Unadjusted quoted prices in
active markets that are accessible at the measurement date for identical,
unrestricted assets or liabilities;





Level 2 -  Quoted prices in
markets that are not active, or inputs that are observable, either directly or
indirectly, for substantially the full term of the asset or


liability;





Level 3 -
Prices or valuation techniques that require inputs that are both significant to
the fair value measurement and unobservable (i.e., supported by little


or no market
activity).




A financial instrument’s level within
the fair value hierarchy is based on the lowest level of input that is
significant to the fair value measurement.





The types of instruments valued based
on quoted market prices in active markets include most US government and agency
securities, many other sovereign government obligations, liquid mortgage
products, active listed equities and most money market securities. Such
instruments are generally classified within Level 1 of the fair value
hierarchy.  As required by fair value guidance, the Company does not
adjust the quoted price for such instruments.






18





The types of instruments valued based
on quoted prices in markets that are not active, broker or dealer quotations, or
alternative pricing sources with reasonable levels of price transparency include
most investment-grade and high-yield corporate bonds, less liquid mortgage
products, less liquid listed equities, state, municipal and
provincial obligations, and certain physical commodities. Such instruments
are generally classified within Level 2 of the fair value
hierarchy.





Level 3 is for positions that are not
traded in active markets or are subject to transfer restrictions, valuations are
adjusted to reflect illiquidity and/or non-transferability, and such adjustments
are generally based on available market evidence. In the absence of such
evidence, management’s best estimate is used.  Management’s best
estimate consists of both internal and external support on certain Level 3
investments.  Internal cash flow models using a present value formula
along with indicative exit pricing obtained from broker/dealers were used to
support the fair value of certain Level 3 investments.  Management
only changes Level 3 inputs and assumptions when corroborated by evidence such
as transactions in similar instruments, completed or pending third-party
transactions in the underlying investment or comparable entities,
subsequent rounds of financing, recapitalizations and other transactions across
the capital structure, offerings in the equity or debt markets, and changes
in financial ratios or cash flows.





Both observable and unobservable inputs
may be used to determine the fair value of positions that the Company has
classified within the Level 3 category. As a result, any unrealized gains and
losses for assets within the Level 3 category may include changes in fair value
attributable to both observable (e.g., changes in market interest rates) and
unobservable (e.g., changes in unobservable long-dated volatilities)
inputs.





The majority of the Company’s
investments fair valued under Level 3 criteria consist of the Company’s stock
ownership in both the Federal Home Loan bank of Pittsburgh and the Federal
Reserve Bank of Philadelphia, part of the membership requirements of these
organizations.  There is no trading market for these securities which
are subject to redemption by the issuers at par, representing both the carrying
value and the fair value on the Company’s books.





Interest
rate swap agreements are measured by alternative pricing sources with reasonable
levels of price transparency in markets that are not active.  Based on
the complex nature of interest rate swap agreements, the markets these
instruments trade in are not as efficient and are less liquid than that of the
more mature Level 1 markets.  These markets do however have
comparable, observable inputs in which an alternative pricing source values
these assets in order to arrive at a fair market value.  These
characteristics classify interest rate swap agreements as Level 2.





The following table sets forth the
Company’s financial assets and liabilities that were accounted for at fair
values on a recurring basis as of September 30, 2009 and December 31, 2008 by
level within the fair value hierarchy.  Financial assets and
liabilities are classified in their entirety based on the lowest level of input
that is significant to the fair value measurement:




Quoted
      Prices
              
              
              Significantin
      Active
              
              
              Other
              
              
              Significant
              
              
              BalanceMarkets
      for
              
              
              Observable
              
              
              Unobservable
              
              
              as
      ofIdentical
      Assets
              
              
              Inputs
              
              
              Inputs
              
              
              September
      30,(dollars
      in thousands)
              
              (Level
      1)
              
              
              (Level
      2)
              
              
              (Level
      3)
              
              
              2009September
      30, 2009AssetsInvestment
      securities available for sale
              
              $
              6,736
              
              
              $
              1,536,106
              
              
              $
              93,181
              
              
              $
              1,636,023Interest
      rate locks
              
              
              -
              
              
              
              476
              
              
              
              -
              
              
              
              476Interest
      rate swap agreements
              
              
              -
              
              
              
              21,473
              
              
              
              -
              
              
              
              21,473LiabilitiesSubordinated
      debt
              
              $
              58,755
              
              
              $
              -
              
              
              $
              -
              
              
              $
              58,755Interest
      rate swap agreements
              
              
              -
              
              
              
              24,510
              
              
              
              -
              
              
              
              24,510Quoted
      Prices
              
              
              Significantin
      Active
              
              
              Other
              
              
              Significant
              
              
              BalanceMarkets
      for
              
              
              Observable
              
              
              Unobservable
              
              
              as
      ofIdentical
      Assets
              
              
              Inputs
              
              
              Inputs
              
              
              December
      31,(dollars
      in thousands)
              
              (Level
      1)
              
              
              (Level
      2)
              
              
              (Level
      3)
              
              
              
              2008December
      31, 2008AssetsInvestment
      securities available for sale
              
              $
              27,397
              
              
              $
              1,492,702
              
              
              $
              73,700
              
              
              $
              1,593,799Interest
      rate locks
              
              
              -
              
              
              
              369
              
              
              
              -
              
              
              
              369Interest
      rate swap agreements
              
              
              -
              
              
              
              30,124
              
              
              
              -
              
              
              
              30,124LiabilitiesSubordinated
      debt
              
              $
              50,659
              
              
              $
              -
              
              
              $
              -
              
              
              $
              50,659Interest
      rate swap agreements
              
              
              -
              
              
              
              33,362
              
              
              
              -
              
              
              
              33,362


19







The
following table presents additional information about assets measured at fair
value on a recurring basis and for which the Company has utilized Level 3 inputs
to determine fair value:





September
      30, 2009
              
              
              December
      31, 2008Investment
              
              
              InvestmentSecurities
              
              
              Securities(dollars
      in thousands)
              
              Available
      for Sale
              
              
              Available
      for SaleAssetsBeginning
      Balance
              
              $
              73,700
              
              
              $
              194,047Total
      gains/(losses) Included inother
      comprehensive income/(loss)
              
              
              (936
              )
              
              
              (29,027
              )Purchases,
      issuances, and settlements
              
              
              16,873
              
              
              
              3,147Transfer
      into Level 3 from KNBT andChristiana
              
              
              -
              
              
              
              44,813Transfer
      out to held to maturity
              
              
              -
              
              
              
              (139,280
              )Transfer
      in to available for sale
              
              
              3,544
              
              
              
              -Ending
      balance
              
              $
              93,181
              
              
              $
              73,700





The following table sets forth the
Company’s financial assets subject to fair value adjustments (impairment) on
a nonrecurring basis as they are valued at the lower of cost or market.
Assets are classified in their entirety based on the lowest level of input
that is significant to the fair value measurement:





Quoted
      Prices
              
              
              Significantin
      Active
              
              
              Other
              
              
              Significant
              
              
              Balance(dollars
      in thousands)
              
              Markets
      for
              
              
              Observable
              
              
              Unobservable
              
              
              as
      ofSeptember
      30, 2009
              
              Identical
      Assets
              
              
              Inputs
              
              
              Inputs
              
              
              September
      30,(Level
      1)
              
              
              (Level
      2)
              
              
              (Level
      3)
              
              
              2009Loans
      and leases held for sale
              
              $
              9,279
              
              
              $
              -
              
              
              $
              -
              
              
              $
              9,279Impaired
      loans, net
              
              
              -
              
              
              
              -
              
              
              
              103,879
              
              
              
              103,879Quoted
      Prices
              
              
              Significantin
      Active
              
              
              Other
              
              
              Significant
              
              
              Balance(dollars
      in thousands)
              
              Markets
      for
              
              
              Observable
              
              
              Unobservable
              
              
              as
      ofDecember
      31, 2008
              
              Identical
      Assets
              
              
              Inputs
              
              
              Inputs
              
              
              December
      31,(Level
      1)
              
              
              (Level
      2)
              
              
              (Level
      3)
              
              
              2008Loans
      and leases held for sale
              
              $
              3,605
              
              
              $
              -
              
              
              $
              -
              
              
              $
              3,605Impaired
      loans, net
              
              
              -
              
              
              
              -
              
              
              
              27,510
              
              
              
              27,510





Impaired and restructured loans totaled
$117.0 million with a specific reserve of $13.1 million at September
30, 2009, compared to $32.6 million with a specific reserve of $5.1 million at
December 31, 2008. Impaired loans are evaluated and valued at the time the loan
is identified as impaired, at the lower of cost or market
value.  Market value is measured based on the value of the collateral
securing these loans and is classified at a Level 3 in the fair value
hierarchy.  Collateral may be real estate and/or business assets
including equipment, inventory and/or accounts receivable.  The value
of real estate collateral is determined based on appraisals by qualified
licensed appraisers hired by the Company.  Equipment appraisals as
well as receivables and inventory valuations are performed by industry experts
hired by the Credit function.  Appraised value estimates and reported
values may be discounted based on management’s historical knowledge, changes in
market conditions from the time of valuation, and/or management’s expertise and
knowledge of the client and client’s business. Impaired loans are reviewed and
evaluated on at least a quarterly basis for additional impairment and adjusted
accordingly, based on the same factors identified above.





In addition to financial instruments
recorded at fair value in the Company’s financial statements, FASB guidance
requires disclosure of the estimated fair value of all 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.  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.  For
disclosure purposes, 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.





20


The
estimation methodologies, resulting fair values and recorded carrying amounts at
September 30, 2009 and December 31, 2008, were as follows:





September
      30, 2009
              
              
              December
      31, 2008Carrying
              
              
              Estimated
              
              
              Carrying
              
              
              Estimated(dollars
      in thousands)
              
              Amount
              
              
              Fair
      Value
              
              
              Amount
              
              
              Fair
      ValueCash
      and cash equivalents
              
              $
              400,191
              
              
              $
              400,191
              
              
              $
              195,830
              
              
              $
              195,830Investment
      securities available for sale
              
              
              1,636,023
              
              
              
              1,636,023
              
              
              
              1,593,799
              
              
              
              1,593,799Investment
      securities held to maturity
              
              
              612,214
              
              
              
              635,398
              
              
              
              326,090
              
              
              
              284,608





The fair value of cash and cash
equivalents equals historical book value.  The fair value of
investment securities is described and presented above.





For September 30, 2009 and December 31,
2008, the fair value of the net loan portfolio has been estimated using a
discounted cash flow methodology that would approximate an exit or sale price to
the most likely market participants for these loans.




September
      30, 2009
              
              
              December
      31, 2008Carrying
              
              
              Estimated
              
              
              Carrying
              
              
              Estimated(dollars in
      thousands)
              
              Amount
              
              
              Fair
      Value
              
              
              Amount
              
              
              Fair
      ValueNet
      loans (excluding loans held for sale)
              
              $
              6,064,915
              
              
              $
              5,702,290
              
              
              $
              6,228,263
              
              
              $
              6,200,190








Fair value of non-interest bearing
demand deposits has been estimated to equal the carrying amount, which is
assumed to be the amount at which they could be settled. Fair value of interest
bearing deposits is based on the average remaining term of the instruments with
the assumption that the exit value of the instruments would be funded with like
instruments by principal market participants.  Fair value of short
term funding liabilities has been estimated to equal the carrying amount. Fair
value of long-term borrowings is determined based on currentmarket rates
for similar borrowings with similar credit ratings, as well as a further
calculation for valuing the optionality of the conversion feature in certain of
the instruments.  Fair value of subordinated debt that floats with
LIBOR is estimated to equal the carrying amount, while the lone fixed rate
subordinated debt instrument has been valued and recorded at fair value as
discussed above.





September
      30, 2009
              
              
              December
      31, 2008Carrying
              
              
              Estimated
              
              
              Carrying
              
              
              Estimated(dollars
      in thousands)
              
              Amount
              
              
              Fair
      Value
              
              
              Amount
              
              
              Fair
      ValueDeposits
      with no stated maturities
              
              $
              4,035,932
              
              
              $
              4,035,932
              
              
              $
              3,753,173
              
              
              $
              3,753,173Deposits
      with stated maturities
              
              
              2,762,730
              
              
              
              2,779,548
              
              
              
              2,636,713
              
              
              
              2,675,644Repurchase
      agreements, federal fundspurchased
      and short-term borrowings
              
              
              635,911
              
              
              
              635,911
              
              
              
              651,307
              
              
              
              651,307Long-term
      borrowings
              
              
              778,906
              
              
              
              860,688
              
              
              
              955,983
              
              
              
              1,022,885Subordinated
      debt
              
              
              136,076
              
              
              
              136,076
              
              
              
              127,980
              
              
              
              127,980





The
fair value of interest rate swaps is based upon the estimated amount the Company
would receive or pay to terminate the contracts or agreements, taking into
account current interest rates and, when appropriate, the current
creditworthiness of the counterparties.  The fair value of the
Company’s interest rate swaps aggregated to a $3.0 million loss at September 30,
2009 and a $3.2 million loss at December 31, 2008.





13.  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:





Nine
      Months EndedSeptember
      30,(dollars
      in thousands)
                2009
                
                2008Interest
                $       134,831
                
                $      168,584Taxes
                725
                
                18,500


21


The Company’s investing and financing
activities that affected assets or liabilities, but did not result in cash
receipts or cash payments were as follows:




Nine
      Months EndedSeptember
      30,(dollars
      in thousands)
              
              2009
              
              
              2008Transfers
      of loans to other real estate
              
              $
              834
              
              
              $
              1,744Other
      than temporary impairment investments
              
              
              99,625
              
              
              
              20,000Dividends
      accrued not paid on preferred stock
              
              
              521
              
              
              
              -Non-cash
      share based compensation plan transactions
              
              
              860
              
              
              
              2,478Transfer
      of investment securities from available for saleto
      held to maturity
              
              
              251,711
              
              
              
              139,280Transfer
      of investment securities from held to maturityto
      available for sale
              
              
              3,545
              
              
              
              -





Supplemental
cash flow disclosures – reconciliation of cash received in
acquisitions:






Nine
      Months EndedSeptember
      30,(dollars
      in thousands)
              
              2009
              
              
              2008Details
      of acquisition:Fair
      value of assets acquired
              
              $
              1,700
              
              
              $
              3,160,697Fair
      value of liabilities assumed
              
              
              (200
              )
              
              
              (2,664,059
              )Stock
      issued for acquisitions
              
              
              -
              
              
              
              (484,574
              )Cash
      paid for acquisitions
              
              
              1,500
              
              
              
              12,064Cash
      and cash equivalents acquired with acquisitions
              
              
              -
              
              
              
              47,916Cash
      equivalents received in excess of cashpaid
      for businesses acquired
              
              $
              (1,500
              )
              
              $
              35,852












22




Item
2.Management’s Discussion and
Analysis of Financial Condition and Results of Operations
 
 The following discussion and analysis
is intended to assist in understanding and evaluating the major changes in the
earnings performance and financial condition of the Company as of and for the
three and nine months ended September 30, 2009, 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 Company’s consolidated financial statements included in
this Report are unaudited, and as such, are subject to year-end
examination.
 
 CRITICAL
ACCOUNTING POLICIES, JUDGMENTS AND ESTIMATES
 
 The accounting and reporting policies
of the Company conform to GAAP and predominant practice within the financial
services industry.  The preparation of financial statements in
conformity with GAAP requires management to make estimates and assumptions that
affect the amounts reported in the financial statements and the accompanying
notes. Actual results could differ from those estimates.  The
following accounting policies comprise those that management believes are the
most critical to aid in fully understanding and evaluating our reported
financial results:
  ·
              allowance
      for loan and lease losses;·
              goodwill
      impairment;·
              deferred
      tax assets, liabilities, and uncertain tax positions;·
              fair
      value measurements, including assessment of other-than-temporary
      impairment; and·
              business
      combinations.
 
 There
have been no material changes in the Company’s critical accounting policies,
judgments and estimates including assumptions or estimation techniques utilized,
other than those described in the allowance for loan and lease losses section of
this analysis, as compared to the Company's most recent Annual Report on Form
10-K.
 
 
 FINANCIAL
HIGHLIGHTS
 
 Business
and Industry
 
 National Penn Bancshares, Inc. is a
Pennsylvania business corporation and a registered bank holding company
headquartered in Boyertown, Pennsylvania. National Penn operates as an
independent community banking company that offers a diversified range of
financial products principally through its bank subsidiaries, National Penn Bank
and Christiana, as well as an array of investment, insurance and employee
benefit services through its non-bank subsidiaries.
 
 The Company’s business is primarily
accepting deposits from customers through its community offices, and investing
those deposits, together with funds generated from operations and borrowings, in
loans, including commercial business loans, commercial real estate loans,
residential mortgages, consumer loans, and investment securities.
 
 The Company’s strategic plan provides
for it to operate within growth markets focusing on diversification of revenue
sources and increased market penetration in growing geographic
areas.
 
 At
September 30, 2009, National Penn operated 127 offices. It has 124 community
banking offices in Pennsylvania and one office in Maryland through National Penn
Bank and its HomeTowne Heritage Bank, KNBT and Nittany Bank divisions. National
Penn also has two offices in Delaware through its wholly-owned subsidiary,
Christiana Bank & Trust Company.
  The Company’s results of operations are
affected by five major elements: (1) net interest income, or the difference
between interest income earned on loans and investments and interest expense
paid on deposits and borrowed funds; (2) the provision for loan and lease
losses, or the amount added to the allowance for loan losses to provide reserves
for inherent losses on loans and leases; (3) non-interest income, which is made
up primarily of banking fees, wealth management income, insurance income, fair
value measurements and gains and losses from sales of securities or other
transactions; (4) non-interest expense, which consists primarily of salaries,
employee benefits and other operating expenses; and (5) income taxes. Results of
operations are also significantly affected by general economic and competitive
conditions, as well as changes in market interest rates, government policies and
actions of regulatory authorities.
  
 23
 
 Overview
 
 For the
three months ended September 30, 2009, the Company recorded a net loss after
dividends paid on preferred stock totaling $65.2 million, ($63.1 million before
preferred dividend and accretion of warrants), representing an $84.4 million
decrease as compared with net income available to common shareholders of $19.2
million over the same 2008 period.  For the nine months ended
September 30, 2009, the Company recorded a net loss after dividends paid on our
preferred stock totaling $73.1 million, ($66.8 million before preferred dividend
and accretion of warrants), a $121.1 million decrease as compared with net
income available to common shareholders of $48.0 million over the same 2008
period.  The primary reason for reduced net income over both periods
was increased provisioning for loan losses and other-than-temporary impairment
write-down (OTTI) on the Company’s investments in collateralized debt
obligations (CDO).  Diluted loss per share after dividends paid and
accretion of warrants on our preferred stock was $(0.65) for the three month
period ending September 30, 2009, an $0.88 decrease as compared to $0.23 over
the same period in 2008. Diluted loss per share after dividends paid on our
preferred stock was $(0.81) for the nine month period ending September 30, 2009,
a $1.71 decrease as compared to $0.90 over the same period in
2008.   Core diluted earnings per share available to common
shareholders were $(0.01) for the nine month period ended September 30, 2009,
compared to $1.01 for the same period in 2008, a $1.02 per share
decrease.
 
 During
September 2009, the Company raised $153 million of new common
equity.  This follows the successful second quarter 2009 completion of
a $72 million capital raise through our dividend reinvestment
plan.  The September capital raise, along with other balance sheet
management strategies, resulted in improvement of regulatory capital ratios
since June 30, 2009.  Management believes that these strong capital
levels are vital in the challenging economic environment.
  At
September 30, 2009, the annualized return on average shareholders’ equity and
annualized return on average assets were (7.39) % and (0.93) %, respectively,
compared to 9.34% and 1.04% for the comparable period in 2008.  The
annualized return on average tangible equity and average tangible common equity
was (14.45%) and (18.86%), respectively, as of September 30, 2009 and 20.62 % at
September 30, 2008.
  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 National Penn’s performance.  One
such measure, annualized 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.  The other
such measure, core net income (or core earnings), excludes the effects of
non-core, after-tax unrealized gains and losses.  Management believes
the presentation of these financial measures, excluding the impact of the
specified items, provides useful supplemental information that is essential to a
proper understanding of the financial results of National Penn.  In
the case of annualized return on average tangible equity, it provides a method
to assess management’s success in utilizing the company’s tangible
capital.  In the case of core net income (or core earnings), it
provides a method to assess earnings performance excluding one-time
items.  This disclosure should not be viewed as a substitute for
results determined in accordance with GAAP, nor is it necessarily comparable to
non-GAAP performance measures that may be presented by other
companies.
  24
  The
following table reconciles this non-GAAP core earnings performance measure to
the GAAP performance measure of net income and diluted earnings per
share.
  Nine
      Months Ended(dollars
      in thousands)
                
                September
      30, 2009
                
                
                September
      30, 2008Net
      Income (loss) available to common shareholders
                
                $
                (73,084
                )
                
                $
                68,035After
      tax unrealized fair market value gain on NPBCapital
      Trust II Preferred Securities
                
                
                5,262
                
                
                
                (3,569
                )After
      tax (gain) loss on investment securities
                
                
                2,046
                
                
                
                (429
                )After
      tax other-than-temporary impairment chargeon  synthetic
      CDO investment
                
                
                64,757
                
                
                
                13,000After
      tax insurance proceeds
                
                
                (2,618
                )
                
                
                -After
      tax special FDIC assessment
                
                
                3,006
                
                
                
                -Core
      net income
                
                $
                (631
                )
                
                $
                77,037Basic
      earnings (loss) available to common shareholders
                
                $
                (0.81
                )
                
                $
                0.90After
      tax unrealized fair market value gain on NPBCapital
      Trust II Preferred Securities
                
                
                0.06
                
                
                
                (0.05
                )After
      tax (gain) loss on investment securities
                
                
                0.02
                
                
                
                (0.01
                )After
      tax other-than-temporary impairment chargeon
      synthetic CDO investment
                
                
                0.72
                
                
                
                0.17After
      tax insurance proceeds
                
                
                (0.03
                )
                
                
                -After
      tax special FDIC assessment
                
                
                0.03
                
                
                
                -Core
      diluted earnings per share
                
                $
                (0.01
                )
                
                $
                1.01
 
 The
following table reconciles the non-GAAP performance measure, annualized return
on average tangible equity, to the GAAP performance measure, annualized return
on average shareholders’ equity:
  Nine
      Months Ended September 30,(dollars
      in thousands, percentages annualized)
                
                2009
                
                
                2008Return
      on average shareholders' equity
                
                
                -7.39
                %
                
                
                9.34
                %Effect
      of goodwill and intangibles
                
                
                -7.06
                %
                
                
                11.28
                %Return
      on average tangible equity
                
                
                -14.45
                %
                
                
                20.62
                %Effect
      of Preferred Stock
                
                
                -4.41
                %
                
                
                0.00
                %Return
      on average tangible common equity
                
                
                -18.86
                %
                
                
                20.62
                %Average
      tangible equity excludes acquisitionrelated
      average goodwill and intangibles:Average
      shareholders' equity
                
                $
                1,209,042
                
                
                $
                973,495Average
      goodwill and intangibles
                
                
                (590,736
                )
                
                
                (532,771
                )Average
      tangible equity
                
                $
                618,306
                
                
                $
                440,724Average
      common equity
                
                
                1,064,492
                
                
                
                973,495
                *Average
      tangible common equity
                
                
                473,756
                
                
                
                440,724*
      No preferred stock was issued as of September 2008**
      Ratios exclude preferred dividend.
 FINANCIAL CONDITION AND
RESULTS OF OPERATIONS
 
 Comparison
of Financial Condition as of September 30, 2009 and December 31,
2008
 
 Assets
  The
Company’s total assets were $9.74 billion at September 30, 2009, an increase of
$336.9 million or 3.6% from the $9.40 billion at December 31, 2008. The increase
was primarily the result of total cash and cash equivalents increasing $204.4
million or 104.4% to $400.2 million, as compared to $195.8 million total at
December 31, 2008.  In addition, the Company’s total investment
portfolio, including both held to maturity and available for sale instruments
increased $328.3 million or 17.1% to $2.25 billion, as compared with $1.92
billion at December 31, 2008.  Gross loans, including loans held for
sale were $6.20 billion at September 30, 2009 a $116.2 million or 1.8% decrease
when compared to $6.32 billion at December 31, 2008.
  The
primary reasons for the increase in total cash and due from banks was
significant customer deposit growth and proceeds from the new common equity and
Dividend Reinvestment Plan.   The Company achieved a higher than
expected liquidity position. The growth in the Company’s total investment
portfolio was primarily the result of deploying the cash proceeds obtained from
the common stock issuance along with a portion of the liquidity provided by
deposit growth, into high quality, short-term
investments.  Notwithstanding the new loan originations in 2009, loan
demand declined in 2009 compared to the same nine month period last
year.
   25
  As of
September 30, 2009, the Company’s total loan portfolio consisted of three broad
categories of loans:
 
 ·
              Loans
      to individuals to finance the purchase of personal assets or activities
      are substantially collateralized by residential real estate. This
      represents $975.8 million or 15.8% of total loans.·
              Residential
      mortgage loans for the purchase or financing of an individual’s private
      residence were $1.01 billion or 16.2% of total loans. The Company’s
      residential mortgage loan portfolio consists substantially of
      “prime/agency” loans, which are based on 80% of appraised value and are
      made to borrowers with average or better credit ratings.·
              Commercial
      loans were $4.22 billion or 68.0% of the total loan portfolio. This
      category includes commercial and industrial loans, commercial real estate,
      and commercial construction loans.
 
 Investment securities (including both
available-for-sale and held-to-maturity) totaled $2.25 billion at September 30,
2009, a 17.1% increase from $1.92 billion at December 31, 2008. The Company
intends to maintain a level of investment securities that is sufficient to
maintain its pledging and collateralized borrowing requirements while also
temporarily deploying excess liquidity.
 
 The
Company early adopted Recognition and Presentation of
Other-Than-Temporary-Impairments issued by the FASB on April 9, 2009.
This new guidance requires that credit-related OTTI be recognized in earnings
while noncredit-related OTTI on securities not expected to be sold is recognized
in other comprehensive income/(loss) (“OCI”). Refer to Note 2, Investment
Securities for a further discussion of securities impairment.
 
 Also
under the new guidance, the Company reclassified the noncredit-related portion
of OTTI losses previously recognized in earnings during 2008. The $12.4 million
after-tax amount was reflected as a cumulative effect adjustment that increased
retained earnings and decreased accumulated OCI. This reclassification had a
positive impact on regulatory capital and no impact on tangible common
equity.
 
 Allowance
for Loan and Lease Losses and Non-Performing Assets
 
 Management
conducts a quarterly analysis of the loan portfolio which includes any loan
designated as having a high risk profile including but not limited to, loans
classified as “Substandard” or “Doubtful” as defined by regulation, loans
criticized internally or designated as “Special Mention”, delinquencies,
expirations, overdrafts, loans to customers having experienced recent operating
losses and loans identified by management as impaired.   The
analysis is performed to determine the amount of the allowance which would be
adequate to absorb probable losses contained in the loan
portfolio.  The analytical process is regularly reviewed and
adjustments may be made based on the assessments of internal and external
influences on credit quality.
 
 The following table shows the
composition of the Allowance for Loan and Lease Losses:
  (dollars
      in thousands)
                
                09/30/09
                
                
                12/31/08
                
                
                12/31/07
                
                
                12/31/06
                
                
                12/31/05Specific
      reserves
                
                $
                13,128
                
                
                $
                5,086
                
                
                $
                613
                
                
                $
                1,307
                
                
                $
                1,716Allocated
      reserves
                
                
                110,916
                
                
                
                72,368
                
                
                
                54,162
                
                
                
                56,787
                
                
                
                52,189Unallocated
      reserves
                
                
                1,446
                
                
                
                6,552
                
                
                
                122
                
                
                
                212
                
                
                
                2,159Total
      Allowance for Loan and Lease Losses
                
                $
                125,490
                
                
                $
                84,006
                
                
                $
                54,897
                
                
                $
                58,306
                
                
                $
                56,064
  26
  The following table shows asset quality
indicators for the periods presented:
  (dollars
      in thousands)
                
                09/30/09
                
                
                12/31/08
                
                
                12/31/07
                
                
                12/31/06
                
                
                12/31/05Nonperforming
      loans
                
                $
                120,120
                
                
                $
                35,586
                
                
                $
                15,285
                
                
                $
                8,648
                
                
                $
                12,144Nonperforming
      loans to total loans
                
                
                1.94
                %
                
                
                0.56
                %
                
                
                0.39
                %
                
                
                0.24
                %
                
                
                0.40
                %Delinquent
      loans
                
                $
                30,885
                
                
                $
                20,782
                
                
                $
                7,041
                
                
                $
                8,196
                
                
                $
                3,399Delinquent
      loans to total loans
                
                
                0.50
                %
                
                
                0.33
                %
                
                
                0.18
                %
                
                
                0.23
                %
                
                
                0.11
                %Classified
      loans
                
                $
                483,163
                
                
                $
                196,349
                
                
                $
                68,970
                
                
                $
                66,390
                
                
                $
                74,756Classified
      loans to total loans
                
                
                7.79
                %
                
                
                3.11
                %
                
                
                1.78
                %
                
                
                1.83
                %
                
                
                2.45
                %Tier
      1 capital and ALLL
                
                $
                953,175
                
                
                $
                825,628
                
                
                $
                454,063
                
                
                $
                423,390
                
                
                $
                374,478Classified
      loans to tier 1 capital and ALLL
                
                
                50.69
                %
                
                
                23.78
                %
                
                
                15.19
                %
                
                
                15.68
                %
                
                
                19.96
                %Total
      loans and leases, including loans held for sale
                
                $
                6,199,684
                
                
                $
                6,315,874
                
                
                $
                3,875,253
                
                
                $
                3,631,937
                
                
                $
                3,049,808
 Specific
Reserve
 
 The first element of the ALLL is the
specific reserve which is an estimation of losses specific to individual
impaired loans.  In this process, specific reserves are established
based on an analysis of the most probable sources of repayment and liquidation
of collateral.  The specific reserves related to impaired loans are
set forth in the previous table detailing the components of the
ALLL.  While every nonperforming loan is individually evaluated, not
every loan requires a specific reserve.  Specific reserves fluctuate
based on changes in the underlying loans and charge-offs.
 
 Allocated
Reserves
 
 The
second element of the ALLL, the allocated reserves, represents a general
allowance for loan pools where the loans are not individually evaluated, though
rated according to loan product type and risk rating.  This amount is
determined by applying loss factors to pools of loans within the portfolio
having similar risk characteristics.
 
 For each
homogeneous pool of loans, a historical loss factor is generated using losses
over five 12-month periods from the current quarter end for a total of sixty
months.  The factor is then multiplied by the current quarter’s
non-criticized and non-classified loan balances.
 
 In addition, environmental factors are
considered for areas of concern that cannot be fully quantified in the
allocation based on historical net charge-off ratios.  Environmental
factors include:
 
 ·
              Economic
      outlook
 ·
              Trends
      in delinquency and problem loans
 ·
              Trends
      in loan volume
 ·
              Effects
      of changes in lending policy
 ·
              Experience,
      ability, and depth of lending
management
 ·
              Concentrations
      of credit
 ·
              Board
      and Loan Review oversight
 ·
              Competition
      and other external factors
 
 For
non-criticized, performing loans, an estimate of adequacy is made by applying
portfolio-specific environmental factors to the period-end
balances.  Management used a higher percentage factor for criticized
and classified loans, given their potential for higher
loss.  Consideration was also given to the type and collateral of the
loans with particular attention paid to Commercial Real Estate Construction
Loans, due to the inherent risk of this type of loan.
 
 As
referenced in the asset quality table, the levels of delinquent, nonperforming
and classified loans have trended upward for the periods
presented.  These are primary factors in the determination of the
ALLL.  At September 30, 2009, nonperforming loans totaled $120.1
million as compared with $35.6 million and $15.3 million at December 31, 2008
and 2007, respectively.  When compared to total loans, nonperforming
loans have risen to 1.94% at September 30, 2009, up from 0.56% at December 31,
2008.  Increases within the Commercial and Real Estate Construction
areas were the product categories primarily responsible for the
increases.
 
 Delinquent
loans at September 30, 2009 were $30.9 million, compared to $20.8 million at
December 31, 2008.  Delinquent loans equaled 0.50% and 0.33% of total
loans as the aforementioned dates, respectively.  Delinquent loans are
considered performing loans and exclude nonaccrual loans, restructured loans and
loans 90 days or more delinquent and still accruing interest (all of which are
considered nonperforming loans).
   27
  As of
September 30, 2009, classified loans relative to total loans amounted to 7.76%,
as compared with 3.11% at December 31, 2008, and 1.78% at December 31, 2007. The
increased level in classified loans is attributed to the national and regional
economic slowdown.
 
 Based on
the increase in delinquent, nonperforming and classified loans, the Company
increased its provision for loan and lease loss and its allocated reserve to
reflect the deterioration of the overall economy, credit quality trends in the
portfolio, and regulatory guidance and expectations.  Management
increased staff levels in the workout and collection areas in recognition of the
increased levels of delinquent, nonperforming and classified loans.
 
 Unallocated
Reserve
 
 The third element of the ALLL is the
unallocated reserve that addresses inherent probable losses not included
elsewhere in the ALLL.  The unallocated reserve decreased from
December 2008 to September 2009 as the allocated portion of the reserve
associated with higher levels of problem loans and economic factors
increased.
 
 Allowance
Adequacy
 
 The Company made a provision for the
three months ended September 30, 2009 of $52.0 million.  This
represents an increase of $14.5 million as compared to the provision for three
months ended June 30, 2009.  Company management believes that the ALLL
of $125.5 million, or 2.02% of total loans and leases at September 30, 2009, is
adequate based on its review of overall credit quality indicators and ongoing
loan monitoring processes.
 
 The following table shows detailed
information and ratios pertaining to the Company’s loans and asset
quality:
  September
      30,
                
                
                
                December
      31,(dollars
      in thousands)
                
                2009
                
                
                
                2008Restructured
      loans
                
                $
                589
                
                
                
                $
                623Nonaccrual
      loans and leases
                
                
                116,418
                
                
                
                
                31,972Impaired
      and restructured loans
                
                
                117,007
                
                
                
                
                32,595Loans
      past due 90 or more days as to interest or principal
                
                
                3,113
                
                
                
                
                2,991Total
      non-performing loans
                
                
                120,120
                
                
                
                
                35,586Other
      real estate owned
                
                
                826
                
                
                
                
                1,552Total
      non-performing loans and ORE
                
                $
                120,946
                
                
                
                $
                37,138Total
      loans and leases, including loans held for sale
                
                $
                6,199,684
                
                
                
                $
                6,315,874Average
      total loans and leases
                
                $
                6,337,201
                
                
                
                $
                5,936,805Allowance
      for loan and lease losses
                
                $
                125,490
                
                
                
                $
                84,006Allowance
      for loan and lease losses to:Non-performing
      loans and ORE
                
                
                103.76
                %
                
                
                
                226.20
                %Total
      loans and leases
                
                
                2.02
                %
                
                
                
                1.33
                %Average
      total loans and leases
                
                
                1.98
                %
                
                
                
                1.42
                %
  28
  An
analysis of loan and lease charge-offs for the three and nine months ended
September 30, 2009 compared
to 2008 is as follows:
  For
      Nine Months Ended
                
                
                For
      Three Months EndedSeptember
      30,
                
                
                September
      30,(dollars
      in thousands)
                
                2009
                
                
                2008
                
                
                2009
                
                
                2008Net
      charge-offs
                
                $
                65,541
                
                
                $
                11,083
                
                
                $
                24,823
                
                
                $
                4,822Net
      charge-offs (annualized) to:Total
      loans and leases
                
                
                1.41
                %
                
                
                0.24
                %
                
                
                1.60
                %
                
                
                0.31
                %Average
      total loans and leases
                
                
                1.38
                %
                
                
                0.25
                %
                
                
                1.57
                %
                
                
                0.32
                %Allowance
      for loan and lease losses
                
                
                69.60
                %
                
                
                17.66
                %
                
                
                79.10
                %
                
                
                23.04
                %
 The Company’s net charge-offs were
$65.5 million for the nine months ended September 30, 2009 compared to the $11.1
million net charge-offs during the same nine month period in
2008.  The increased charge-offs were in the Commercial, Real Estate
Construction and Consumer Private Banking product lines.  The Private
Banking charge-offs were largely related to one customer with exposure to the
Madoff fraud.    This increase in charge-offs is a direct
result of the economic downturn in both the national and regional
economy.
  Liabilities
  Liabilities
totaled $8.38 billion at September 30, 2009 an increase of $156.8 million or
1.9% compared to liabilities of $8.22 billon at December 31, 2008. Aggregate
deposits, the primary source of the Company’s funds, increased $408.8 million or
6.4% to $6.80 billion at September 30, 2009 as compared with $6.39 billion
at       December 31, 2008. The increase in
interest earning deposits is a reflection of both the Company’s attractive
deposit products and the economic environment, causing consumers to be
conservative in their approach to investing and to seek safety.
 
 In
addition to deposits, earning assets are funded to an extent through purchased
funds and borrowings. These include securities sold under repurchase agreements,
federal funds purchased, short-term borrowings, long-term debt obligations and
subordinated debt. In the aggregate, these funds totaled $1.55 billion at
September 30, 2009, a decrease of $184.4 million or 10.6% over $1.74 billion at
December 31, 2008.   The Company reduced long-term borrowings to
$778.9 million, a $177.1 million or 18.5% decrease as compared to $956.0 million
at December 31, 2008.  The Company utilized a portion of its increased
liquidity to reduce debt.
  Shareholders’
Equity
  Shareholders’ equity increased $180.1
million or 3.6% to $1.36 billion at September 30, 2009, compared to $1.18
billion at December 31, 2008. Common stock increased $223.9 million or 22.3% to
$1.00 billion.  The primary reason was the issuance of 30.7 million
shares of National Penn common stock at $5.25 per share during
September.  National Penn’s net proceeds from the offering, including
the underwriters’ exercise of the over-allotment option, after deducting
underwriting discounts and commissions and estimated offering expenses, was
approximately $153.5 million.  In addition, the Company enhanced its
Dividend Reinvestment and Stock Purchase Plan, providing a 10% discount on
dividends reinvested as well as for new cash purchases made under the Plan, from
November 2008 through June 12, 2009. Through this vehicle, the Company raised
$68.9 million in tangible common equity during 2009.
 
 At
September 30, 2009, accumulated other comprehensive income (loss) increased
$37.6 million or 116.2% compared to the December 31, 2008 amount.  The
primary reason for the increase was due to increased valuation levels in
available-for-sale securities.  In addition, during the quarter ended
September 30, 2009, the Company recognized OTTI on CDO securities that were
deemed credit-related.  Thus, the Company reclassified prior
non-credit after-tax charges from accumulated other comprehensive income to
retained earnings. The reclassification decreased retained earnings and
increased accumulated other comprehensive income (loss). Based upon FASB
guidance regarding OTTI, the Company performed a detailed evaluation and had
previously retrospectively reclassified $12.4 million after-tax loss of
previously recognized OTTI from 2008, and had recognized an additional $16.9
after-tax loss as a non-credit loss from the six months ended June 30, 2009,
back into retained earnings.
 
 Dividends,
declared and accrued, reduced shareholders’ equity by $27.7 million during the
nine months ended September 30, 2009. Net loss of $66.8 million for the nine
months ended September 30, 2009 also reduced shareholders’ equity over the same
period.
  
 29
 
 Goodwill
 
 Business
combinations entered into by the Company typically include the acquisition of
goodwill.  Although goodwill is not subject to amortization, the Company
must test the carrying value for impairment at least annually or more frequently
if events or changes in circumstances indicate that the asset might be impaired.
Impairment testing requires that the fair value of each of our reporting
units be compared to the carrying amount of its net assets, including goodwill.
Our reporting units were identified based upon an analysis of each of our
individual operating segments. A reporting unit is defined as any distinct,
separately identifiable component of an operating segment for which complete,
discrete financial information is available that management regularly reviews.
The Company allocated goodwill to each reporting unit based on its relative fair
value at the time of the related acquisition. Determining the fair value of a
reporting unit requires us to use a high degree of subjectivity.  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 than book value, 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.   The Company retained a third-party valuation
firm to assist in the testing for potential goodwill impairment.  The
Company determined that the Income approach and the Market approach were most
appropriate in determining whether impairment occurred.
 
 The
Income Approach uses a dividend discount analysis. This approach calculates cash
flows based on anticipated financial results assuming a change of control
transaction. This change of control assumes that an acquirer will achieve an
expected base level of earnings, achieve integration cost savings and incur
certain transaction costs (including such items as legal and financial advisors
fees, contract cancellations, severance and employment obligations, and other
transaction costs). The analysis then calculates the present value of all excess
cash flows generated by the company (above the minimum tangible capital ratio)
plus the present value of a terminal sale value.
 
 The
Market Approach is used to calculate the fair value of a company by calculating
median pricing multiples in recent actual acquisitions of companies similarly
sized and then applying these multiples to the Community Banking Segment. This
technique uses historical data to create a current pricing level and is thus a
trailing indicator. Results provided by the Market Approach need to be
understood in this context. It is believed that the current turmoil in the
financial markets is recent and has not yet fully impacted pricing levels of
acquisitions.
 
 Impairment
testing for 2009 for goodwill and intangibles was completed at June 30, 2009 by
management. At that time there was no determination of goodwill or intangible
impairment at National Penn. As prescribed by FASB guidance, goodwill should be
tested for impairment between annual tests if circumstances change that would
more-likely-than-not reduce the fair value of the reporting unit below its
carrying amount.  During the third quarter 2009 the Company experienced
such potential circumstances.  As a result,  the Company
performed testing at September 30, 2009 which determined that the Community
Banking Segment reporting units’ implied fair value exceeded the associated
carrying amount of the Company’s reporting units, therefore no goodwill
impairment was required to be recognized.  Management will continue to
monitor events that could impact this conclusion in future periods.
 
 Results
of operations for the nine months ended September 30, 2009 and 2008
  Net
Interest Income
  Net Interest Income
  Net interest income is the difference
between interest income earned on assets and interest expense paid on
liabilities.  Net interest income for the three months ended September
30, 2009 was $65.2 million, a decrease of $1.8 million or 2.6%, compared to the
$66.9 million for the same 2008 period.  Net interest income for the
nine months ended September 30, 2009 was $184.7 million, a decrease of $4.9
million or 2.6%, compared to the $189.6 million for the same 2008 period. The
primary reason for the slight decline in net interest income for both periods is
the deployment of liquidity generated by increased customer deposits and the
successful capital initiatives, into short-term lower yielding investments and
fed funds.
 
 Interest income for the three months
ended September 30, 2009 was $105.2 million, a $15.5 million or 12.8% decrease
as compared with $120.7 million for the same period in 2008.  Interest
income for the nine months ended September 30, 2009 was $316.8 million, a $33.8
million or 9.6% decrease as compared with $350.6 million for the same period in
2008. The primary reason for the decline in interest income in both periods was
that the interest revenue attributable to the increase in average earning assets
was more than offset by a decrease in yield as the general level of interest
rates declined late 2008 and early 2009. The increased levels of nonperforming
assets and the aforementioned temporary deployment of liquidity also contributed
to the decrease in interest income.
   30
  Interest
expense for the three months ended September 30, 2009 was $40.0 million, a
decrease of $13.7 million or 25.5% compared to $53.8 million for the three
months ended September 30, 2008.  Interest expense for nine months
ended September 30, 2009 was $132.1 million, a decrease of $28.9 million or
17.9% compared to $161.0 million for the nine months ended September 30, 2008.
The primary reason for the decrease in interest expense in both periods was that
with strong liquidity,the
Company employed a strategy of pricing deposit products, maturing time deposits
and corporate cash management accounts less aggressively.
  The following table presents average
balances, average rates and interest rate spread information:
 
 Average Balances, Average
Rates, and Interest Rate Margin*
  Nine
      Months Ended September 30,2009
                
                
                2008Interest
                
                
                Average
                
                
                
                
                
                Interest
                
                
                AverageAverage
                
                
                Income/
                
                
                Yield/
                
                
                Average
                
                
                Income/
                
                
                Yield/(dollars
      in thousands)
                
                Balance
                
                
                Expense
                
                
                Rate
                
                
                Balance
                
                
                Expense
                
                
                RateInterest-earning
      assetsInterest
      bearing balances with banksand
      federal funds sold
                
                $
                36,622
                
                
                $
                66
                
                
                
                0.24
                %
                
                $
                24,345
                
                
                $
                576
                
                
                
                3.16
                %Investment
      securities*
                
                
                2,029,770
                
                
                
                77,406
                
                
                
                5.10
                %
                
                
                1,908,169
                
                
                
                79,784
                
                
                
                5.59
                %Total
      loans and leases*
                
                
                6,337,201
                
                
                
                256,486
                
                
                
                5.41
                %
                
                
                5,829,145
                
                
                
                285,341
                
                
                
                6.54
                %Total
      earning assets
                
                $
                8,403,593
                
                
                $
                333,958
                
                
                
                5.31
                %
                
                $
                7,761,659
                
                
                $
                365,701
                
                
                
                6.29
                %Interest-bearing
      liabilitiesInterest
      bearing deposits
                
                $
                5,987,692
                
                
                $
                88,091
                
                
                
                1.97
                %
                
                $
                5,111,137
                
                
                $
                108,137
                
                
                
                2.83
                %Short-term
      borowings
                
                
                649,644
                
                
                
                9,618
                
                
                
                1.98
                %
                
                
                713,452
                
                
                
                15,750
                
                
                
                2.96
                %Long-term
      borrowings
                
                
                1,004,098
                
                
                
                34,423
                
                
                
                4.58
                %
                
                
                1,121,623
                
                
                
                37,096
                
                
                
                4.41
                %Total
      interest-bearing liabilities
                
                $
                7,641,434
                
                
                $
                132,132
                
                
                
                2.31
                %
                
                $
                6,946,212
                
                
                $
                160,983
                
                
                
                3.10
                %INTEREST
      RATE MARGIN**
                
                
                
                
                
                $
                201,826
                
                
                
                3.21
                %
                
                
                
                
                
                $
                204,718
                
                
                
                3.52
                %Tax
      equivalent interest
                
                
                
                
                
                
                (17,123
                )
                
                
                -0.27
                %
                
                
                
                
                
                
                (15,078
                )
                
                
                -0.26
                %Net
      interest income
                
                
                
                
                
                $
                184,703
                
                
                
                2.94
                %
                
                
                
                
                
                $
                189,640
                
                
                
                3.26
                %*Full taxable equivalent basis, using a 35% effective tax
      rate.**Represents
      the difference between interest earned and interest paid, divided by total
      earning assets.Loans
      outstanding, net of unearned income, include non-accruing
      loans.Fee
      income included.
 The following table presents the dollar
amount of changes in interest income and interest expense for major components
of interest-earning assets and interest-bearing liabilities.  It
distinguishes between the increase related to higher outstanding balances and
that due to the levels and volatility of interest rates.  For each
category of interest-earning assets and interest-bearing liabilities,
information is provided on changes attributable to (i) changes in volume (i.e.,
changes in volume multiplied by old rate) and (ii) changes in rate (i.e.,
changes in rate multiplied by old volume).  For purposes of this
table, variance not solely due to rate or volume is allocated to the volume
variance.  Changes attributable to both rate and volume that cannot be
segregated have been allocated proportionately to the change due to volume and
the change due to rate in proportion to the relationship of the absolute dollar
amounts of the change in each.  The information is presented on a
taxable equivalent basis, using an effective rate of 35%:
  Nine
      Months Ended(dollars
      in thousands)
                
                September
      30, 2009 over 2008Increase
      (decrease) due to:
                
                Volume
                
                
                Rate
                
                
                TotalInterest
      Income:Interest
      bearing deposits in banks and fed funds sold
                
                $
                205
                
                
                $
                (715
                )
                
                $
                (510
                )Investment
      securities
                
                
                13,118
                
                
                
                (15,496
                )
                
                
                (2,378
                )Total
      loans and leases
                
                
                49,426
                
                
                
                (79,281
                )
                
                
                (28,855
                )Total
      interest income
                
                $
                62,749
                
                
                $
                (95,492
                )
                
                $
                (31,743
                )Interest
      Expense:Interest
      bearing deposits
                
                $
                27,020
                
                
                $
                (47,066
                )
                
                $
                (20,046
                )Short-term
      borrowings
                
                
                (188
                )
                
                
                (5,944
                )
                
                
                (6,132
                )Long-term
      borrowings
                
                
                (842
                )
                
                
                (1,831
                )
                
                
                (2,673
                )Total
      interest expense
                
                $
                25,990
                
                
                $
                (54,841
                )
                
                $
                (28,851
                )Increase
      (decrease) in net interest income
                
                $
                36,759
                
                
                $
                (39,652
                )
                
                $
                (2,892
                )
  31
  Net
interest income, on a full taxable equivalent basis, decreased $2.9 million in
the first nine months of 2009, as compared to the same period in
2008.  This change is impacted by volume and rate.  Volume
had a positive impact as the increase in interest income due to higher interest
earning assets was greater than the increase in interest expense on the growth
in interest-bearing liabilities.  Rate had a negative impact in that
decreases in interest income from lower rates on assets were greater than the
decreases in rates on interest-bearing liabilities.  The growth in
interest-earning assets and interest-bearing liabilities resulted from organic
growth.
 
 Net
interest margin on a full taxable equivalent basis, defined as net interest
income divided by total interest earning assets, was 3.21% during the nine
months ended September 30, 2009 compared to 3.52% during the nine months ended
September 30, 2008.  The margin was impacted by rates on earning
assets declining at a faster pace than rates on interest bearing liabilities,
the associated impact of increases in non-performing loans, and the reduced
impact of KNBT’s fair value purchase accounting marks accretion into net
interest income.
 
 Although
the margin has declined during the year over year period ending September 30,
2009, the company has experienced margin expansion during the second and third
quarters of 2009.  The primary reason for margin improvement was the
progress made in the reduction of funding costs.
  Provision
for Loan and Lease Losses
  The
Company’s provision for loan and lease losses is based on interrelated factors
such as the composition of and risk in our loan portfolio, the level of
non-accruing and delinquent loans and the related collateral, as well as
economic considerations. The provision charged to current earnings was $52.0
million for the three months ended September 30, 2009, a $45.1 million increase
as compared to a provision for loan losses of $6.9 million for the three months
ended September 30, 2008. For the nine months ended September 30, 2009, the
provision for loan losses was $107.0 million, a $93.0 million increase over the
$14.0 million provision for the same period in 2008. The increase is primarily
due to increased non-accruing loans and the inherent risk of our commercial loan
portfolio. For a complete analysis of allowance for loan loss please see“Allowance for Loan Losses and
Non-Performing Assets” above.
 
 Non-Interest
Income
 
 Non-interest
income was $(64.1) million for the three months ended September 30, 2009 a $81.0
million decrease as compared with $16.9 million income over same period in
2008.  Non-interest loss was $(27.4) million for the nine months ended
September 30, 2009, a $76.4 million decrease as compared with $49.0 million
income over same period in 2008.  The primary reason for the decrease
in non-interest income was a pre-tax unrealized loss of $84.7 million and $99.6
million, respectively, resulting from an other-than-temporary impairment charge
on the Company’s CDO’s for the three and nine months ended September 30,
2009.
 
 Wealth
management income decreased $569,000 and $2.8 million, respectively for the
three and nine month period ending September 30, 2009 over the same periods last
year. Equity in undistributed net earning (loss) of unconsolidated investments
declined $2.1 million for both the three and nine month period ending September
30, 2009. Both of the aforementioned decreases are a result of the sustained
overall decline of financial markets.  Mortgage banking income
increased $1.0 million and $4.7 million, respectively, for the three and nine
month periods ending September 30, 2009 over the comparable periods in 2008. The
Company attributes this increase to the lower interest rate environment and the
resultant refinance market. Cash management and electronic banking fees
increased $124,000 and $1.1 million, respectively for the three and nine month
periods ending September 30, 2009 over the comparable 2008
periods.  The primary reason for the increase was increased customer
utilization of these services.
  Non-Interest
Expense
 
 Non-interest
expense was $52.1 million for the three months ended September 30, 2009, a $1.9
million or 3.6% decrease as compared with $54.1 million over same period in
2008.  Non-interest expense was $171.5 million for the nine months
ended September 30, 2009, a $14.7 million or 9.4% increase as compared with
$156.8 million over same period in 2008.  The decrease in non-interest
expense for the three month period ending September 30, 2009 over the comparable
period 2008, was due to the receipt of $4.0 million fraud loss recovery through
insurance proceeds.  The increase in non-interest expense for nine
month period ending September 30, 2009 over the comparable 2008 periods was
primarily the result of a special FDIC insurance fund assessment of $4.6 million
and a $1.5 million prepayment penalty on the early retirement of long-term
borrowings.  The FDIC special assessment was in addition to the
increased premiums assessed in 2009.  The early retirement of the
long-term borrowing will generate a positive return over the original maturity
period of the borrowings.
   32
  Income
Tax Expense
 
 The
Company recognized a net book tax benefit of $40.0 million for the three months
ended September 30, 2009, which compares to tax expense of $3.6 million for the
same period in 2008.  For the nine months ended September 30, 2009, the
Company also recognized a tax benefit of $54.4 million compared to $19.7 million
tax expense for the same period in 2009.  The Company’s effective tax rate
was negative at September 30, 2009 due to both the reported net loss, as well as
the level of the Company’s tax advantaged income.
 
 LIQUIDITY AND INTEREST RATE
SENSITIVITY
 
 The primary functions of
asset/liability management are to assure adequate liquidity and maintain an
appropriate balance between interest-earning assets and interest-bearing
liabilities. The Company’s Board of Directors has set general liquidity
guidelines for management to meet, which can be summarized as; the ability to
generate adequate amounts of cash to meet the demand from depositors who wish to
withdraw funds, borrowers who require funds, and capital expansion. Liquidity is
produced by cash flows from our operating, investing, and financing
activities.
  Liquidity
needs generally arise from asset originations and deposit outflows. Liquidity
needs can increase when asset origination (of loans and investments) exceeds net
deposit inflows. Conversely, liquidity needs are reduced when the opposite
occurs. In these instances, the needs are funded through short-term borrowings,
while excess liquidity is sold into the Federal Funds market.
   The
Company’s largest source of liquidity on a consolidated basis is the deposit
base that comes from our retail and corporate and institutional banking
activities. The Company also utilizes wholesale funding that comes from a
diverse mix of short and long-term funding sources. Wholesale funding is defined
here as funding sources outside our core deposit base, such as correspondent
bank borrowings including the Federal Reserve Bank of Philadelphia (FRB) or
brokered CDs. In 2008, the Company opted into the FDIC’s Temporary Liquidity
Guarantee Program. This program provides unlimited deposit insurance for non
interest-bearing transaction accounts, as well as an opportunity for
FDIC-guaranteed unsecured borrowing. The program is set to expire December 31,
2009.
   The
Company’s principal source of day-to-day liquidity is through wholesale, secured
borrowing lines from the Federal Home Loan Bank of Pittsburgh (FHLB) and the
FRB. During the first quarter of 2009, the Company did not access either of
these lines to provide funds for asset growth, as deposit growth was strong. At
no time during 2009 or 2008 did the Company experience any difficulties
accessing these lines. The Company continues to believe it has funds available
to it, and does not anticipate any problem accessing these funds at reasonable
rates. However, regardless of the comfort with the Company’s liquidity position
at the present time, the Company actively monitors its position and any
increased use of wholesale funding increases the Company’s attention in this
area.
  The
Company employs a diverse capital raising strategy which may include acquisition
of additional equity capital. During 2008, the Company completed the sale of its
senior preferred stock totaling $150 million to the U.S. Department of the
Treasury under its TARP Capital Purchase Program. In the transaction, the U.S.
Treasury purchased 150,000 shares of newly issued, non-voting National Penn
senior preferred stock with an aggregate liquidation preference of $150 million
and an initial annual dividend of 5%. U.S. Treasury also received warrants to
purchase 1,470,588 shares of National Penn common stock at an exercise price of
$15.30 per share. In fourth quarter 2008, the Company enhanced its Dividend
Reinvestment and Stock Purchase Plan (“DRP”) to provide a 10% discount on
dividends reinvested as well as for new voluntary cash purchases made under the
DRP. Voluntary cash contributions could be made in amounts up to $50,000 per
month, an increase from the prior monthly limitation of $10,000. In April 2009,
the Company amended the DRP again, raising the limit on voluntary monthly cash
contributions to $250,000. The Company terminated the enhanced DRP cash
contribution provisions in June 2009 earlier than originally anticipated, due to
the success of this capital raising effort as demonstrated by our receipt of a
total of $72.4 million in new common equity, $52.2 million of which was raised
in the second quarter of 2009.
  In
September 2009, National Penn issued 30.7 million shares of its common stock at
$5.25 per share. This issuance includes 26.7 million shares initially announced
and 4.0 million shares purchased by underwriters through exercising their
over-allotment option. National Penn’s net proceeds from the offering, including
the exercise of the over-allotment option, after deducting underwriting
discounts and commissions and estimated offering expenses was approximately
$153.1 million.
  National
Penn may use the net proceeds from this offering for general corporate purposes
which may include, among other uses, making investments at the holding company
level, providing capital to support National Penn's subsidiaries, including
National Penn Bank, supporting asset and deposit growth, engaging in
acquisitions or other business combinations, reducing or refinancing existing
debt or the repurchase of the Series B Preferred Stock and the warrant issued to
the U.S. Treasury pursuant to National Penn's participation in the U.S.
Treasury's TARP Capital Purchase Program. National Penn does not have any
specific plans for acquisitions other business combinations at this time. The
repurchase of the Series B Preferred Stock from the U.S. Treasury can be done in
whole or in part and is subject to approval from National Penn's banking
regulators.
   33
  As
measured using the Consolidated Statement of Cash Flows, at September 30, 2009,
the Company provided $204.4 million in net cash and equivalents versus providing
$85.3 at September 30, 2008.
 
 Net cash
provided by operating activities was $88.3 million at September 30, 2009 and
$77.4 million at   September 30, 2008.  During 2009,
the Company increased loan provision to $107.0 million from $14.0 million in
2008.
 
 Net cash
used in investing activities at September 30, 2009 decreased to $298.4 million
from $349.8 million at September 30, 2008.  Purchase of investment
securities available for sale and held to maturity totaled $600.0 million as
compared with a total of $326.6 at September 30, 2008.
 
 Cash
provided by financing activities was $414.5 million at September 30, 2009 versus
$357.8 million at September 30, 2008. The largest source of financing funds in
2009 was the net increase in customer deposits and proceeds from the issuance of
shares under the aforementioned enhanced Dividend Reinvestment and optional cash
purchase program.
 
 The
Company’s biggest source of revenue is net interest income. Therefore, interest
rate risk management is an important function. Interest rate risk is the
Company’s most significant market-based risk. The Company realizes net interest
income principally from the differential or spread between the interest earned
on loans, investments and other interest-earning assets and the interest paid on
deposits and borrowings. Loan volumes and yields, as well as the volume and
rates on investments, deposits and borrowings, are affected by market interest
rates. Additionally, because of the terms and conditions of many of our loans
and deposit accounts, a change in interest rates could also affect the projected
maturities of the loan portfolio and/or the deposit base, which could alter our
sensitivity to future changes in interest rates.
  Interest
rate risk management focuses on maintaining consistent growth in net interest
income within Board-approved policy limits while taking into consideration,
among other factors, overall credit risk, operating income, operating costs, and
available capital. The Company’s Asset/Liability Committee ("ALCO") includes the
Company's President and senior officers in various disciplines including
Treasury, Finance, Commercial Lending, Retail Lending, and Marketing. An
independent member of the Board of Directors, on a rotating basis, attends ALCO
meetings. The Committee reports to the Board on its activities to monitor and
manage interest rate risk through Director’s Enterprise Risk Management
Committee.
  Management
of interest rate risk leads us to select certain techniques and instruments to
utilize after considering the benefits, costs and risks associated with
available alternatives. We usually consider one or more of the following: (1)
interest rates offered on products, (2) maturity terms offered on products, (3)
types of products offered, and (4) products available to us in the wholesale
market such as advances from the FHLB and brokered time deposits.
  ALCO's
principal focus is net interest income at risk. The Company utilizes a net
interest margin shock simulation model as one method to identify and manage our
interest rate risk profile. The model measures projected net interest income
"at-risk" and anticipated resulting changes in net income and economic value of
equity. The model is based on expected cash flows and repricing characteristics
for all financial instruments at a point in time and incorporates our
market-based assumptions regarding the impact of changing interest rates on
these financial instruments over a twelve-month period. The Company also
incorporates assumptions based on the historical behavior of deposit rates and
balances in relation to changes in interest rates. These assumptions are
inherently uncertain and, as a result, the model cannot precisely measure net
interest income or precisely predict the impact of fluctuations in interest
rates on net interest income. While actual results will differ from simulated
results due to timing, magnitude, and frequency of interest rate changes, as
well as changes in market conditions and management strategies, this model has
proven to be an important guidance tool for ALCO. The following table sets forth
the results of this model for National Penn Bank and Christiana, the principal
entities exposed to market risk, at September 30, 2009.
   34
  The following table shows separately
the interest rate sensitivity of each category of interest earning assets and
interest bearing liabilities at September 30, 2009:
 
 Three
      Months
                
                
                One
      YearWithin
                
                
                Through
                
                
                Through
                
                
                Over(dollars
      in thousands)
                
                Three
      Months
                
                
                One
      Year
                
                
                Five
      Years
                
                
                5
      Years
                
                
                TotalInterest-earning
      assets:Interest
      bearing deposits
                
                $
                44,511
                
                
                $
                -
                
                
                $
                -
                
                
                $
                -
                
                
                $
                44,511Investment
      securities
                
                
                269,901
                
                
                
                418,118
                
                
                
                712,544
                
                
                
                891,216
                
                
                $
                2,291,779Loans
      and Leases (1)
                
                
                2,623,056
                
                
                
                961,971
                
                
                
                2,005,657
                
                
                
                483,509
                
                
                $
                6,074,193Total
      interest-earning assets
                
                $
                2,937,468
                
                
                $
                1,380,089
                
                
                $
                2,718,201
                
                
                $
                1,374,725
                
                
                $
                8,410,483Cumulative
      total interest-earning
      assets
                
                $
                2,937,468
                
                
                $
                4,317,557
                
                
                $
                7,035,758
                
                
                $
                8,410,483
                
                
                $
                8,410,483Interest
      bearing liabilities:Interest
      bearing deposits
                
                $
                4,018,885
                
                
                $
                1,234,360
                
                
                $
                825,456
                
                
                $
                1,503
                
                
                $
                6,080,204Borrowed
      funds
                
                
                492,469
                
                
                
                50,387
                
                
                
                447,023
                
                
                
                424,938
                
                
                
                1,414,817Subordinated
      debt
                
                
                77,321
                
                
                
                -
                
                
                
                -
                
                
                
                58,755
                
                
                
                136,076Total
      interest-bearingliabilities
                
                $
                4,588,675
                
                
                $
                1,284,747
                
                
                $
                1,272,479
                
                
                $
                485,196
                
                
                $
                7,631,097Cumulative
      total interest-bearing
      liabilities
                
                $
                4,588,675
                
                
                $
                5,873,422
                
                
                $
                7,145,901
                
                
                $
                7,631,097
                
                
                $
                7,631,097Interest-earning
      assetsless
      interest bearingliabilities
                
                $
                (1,651,207
                )
                
                $
                (1,555,865
                )
                
                $
                (110,143
                )
                
                $
                779,386
                
                
                $
                779,386Cumulative
      interest-ratesensitivity
      gap
                
                $
                (1,651,207
                )
                
                $
                (3,207,072
                )
                
                $
                (3,317,215
                )
                
                $
                (2,537,829
                )
 (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 nine months of
      2009.  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.
 Interest rate sensitivity is a function
of the way the Company’s assets and liabilities reprice. 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 rate environment and would decrease in a rising 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
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.
  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.
  At the
current level of interest rates, the Company’s Economic Value of Equity has some
exposure to a movement in rising rates due to the amount of repriceable
liabilities in the short-term and the optionality of the financial instruments
on both sides of the balance sheet. Optionality exists because customers have
choices regarding their deposit accounts or loans. For example, if a customer
has a fixed rate mortgage, he/she may choose to refinance the mortgage if
interest rates decline. One way to reduce this option risk is to sell the
Company’s long-term fixed rate mortgages in the secondary market.
   35
  The
calculated estimates of change in MVPE at September 30, 2009 are as
follows:
  (dollars
      in thousands)%
      ChangeMVPE
                
                
                
                
                fromChange
      in Interest Rate
                
                
                Amount
                
                
                Base
      CaseRate
      Scenario+
      300 basis point rate shock
                
                $
                1,037,948
                
                
                
                -13.99
                %+
      200 basis point rate shock
                
                
                1,095,629
                
                
                
                -9.21
                %+
      100 basis point rate shock
                
                
                1,151,344
                
                
                
                -4.59
                %base
      case
                
                
                1,206,710
                
                
                
                0.00
                %-
      100 basis point rate shock
                
                
                1,265,640
                
                
                
                4.88
                %-
      200 basis point rate shock
                
                
                1,262,939
                
                
                
                4.66
                %-
      300 basis point rate shock
                
                
                1,256,157
                
                
                
                4.10
                %
 Management also estimates the potential
effect of shifts in interest rates on net income.  The following table
demonstrates the expected effect that a parallel interest rate shift would have
on the Company’s net income:
  (dollars
      in thousands)
                
                
                September
      30, 2009
                
                
                September
      30, 2008Change
      in
                
                
                Change
      in
                
                
                Change
      in
                
                
                Change
      in
                
                
                Change
      inInterest
      Rates
                
                
                Net
      Income
                
                
                Net
      Income
                
                
                Net
      Income
                
                
                Net
      Income(in
      basis points)+
      300
                
                
                $
                16,628
                
                
                
                47.19%
                
                
                $
                (11,412)
                
                
                
                -9.14%+
      200
                
                
                
                10,564
                
                
                
                29.98%
                
                
                
                (6,060)
                
                
                
                -4.85%+
      100
                
                
                
                4,998
                
                
                
                14.18%
                
                
                
                (2,063)
                
                
                
                -1.65%-
      100
                
                
                
                (1,960)
                
                
                
                -5.56%
                
                
                
                (2,667)
                
                
                
                -2.14%-
      200
                
                
                
                (7,749)
                
                
                
                -21.99%
                
                
                
                (10,778)
                
                
                
                -8.63%-
      300
                
                
                
                (11,595)
                
                
                
                -32.90%
                
                
                
                (21,254)
                
                
                
                -17.03%
 The net
income view of interest rate risk analysis considers the impact to net income
over the next twelve months.  The MVPE view considers the change in
values of each item of the balance sheet at a point in time.  While an
increase in interest rates is expected to produce higher net income in the next
twelve months, the net value of the balance sheet declines in a rising rate
scenario.
 
 The
Company uses financial derivative instruments for management of interest rate
sensitivity. ALCO approves the use of derivatives in balance sheet hedging. The
derivatives employed by the Company currently include forward sales of mortgage
commitments, as well as fair value and cash flow hedges. The Company does not
use any of these instruments for trading purposes. For details of derivatives,
see Note 11 to the consolidated financial statements included in this Report at
Item 1.
 
 OFF-BALANCE SHEET
ARRANGEMENTS AND
 OTHER CONTRACTUAL
OBLIGATIONS AND COMMITMENTS
 
 The
Company consolidates all of its majority-owned subsidiaries.  Other
entities, in which there is greater than 20% ownership, but upon which the
Company does not possess, nor cannot exert, significant influence or control,
are accounted for by equity method accounting and not consolidated; those in
which there is less than 20% ownership are generally carried at
cost.
  36
  Thefollowing table sets forth the contractual obligations and
other commitments representing required and potential
cash outflows as of September 30, 2009:
  Payments
      Due by Period:After
      one
                  
                  
                  After
      threeLess
      Than
                  
                  
                  year
      to
                  
                  
                  years
      to
                  
                  
                  More
      Than(dollars
      in thousands)
                  
                  Total
                  
                  
                  One
      Year
                  
                  
                  three
      years
                  
                  
                  five
      years
                  
                  
                  5
      YearsMinimum
      annual rentals or non-cancelable operating leases
                  
                  $
                  46,731
                  
                  
                  $
                  1,641
                  
                  
                  $
                  11,254
                  
                  
                  $
                  7,870
                  
                  
                  $
                  25,966Remaining
      contractual maturities of time deposits
                  
                  
                  2,762,730
                  
                  
                  
                  1,946,059
                  
                  
                  
                  685,944
                  
                  
                  
                  119,749
                  
                  
                  
                  10,978Loan
      commitments
                  
                  
                  1,636,351
                  
                  
                  
                  945,340
                  
                  
                  
                  133,076
                  
                  
                  
                  29,528
                  
                  
                  
                  528,407Long-term
      borrowed funds
                  
                  
                  778,905
                  
                  
                  
                  67,493
                  
                  
                  
                  176,656
                  
                  
                  
                  49,500
                  
                  
                  
                  485,256Guaranteed
      preferred beneficial interests in Company'ssubordinated
      debentures
                  
                  
                  136,076
                  
                  
                  
                  -
                  
                  
                  
                  -
                  
                  
                  
                  -
                  
                  
                  
                  136,076Letters
      of credit
                  
                  
                  179,919
                  
                  
                  
                  129,747
                  
                  
                  
                  46,774
                  
                  
                  
                  188
                  
                  
                  
                  3,210Dividends
      on Preferred Stock*
                  
                  
                  99,375
                  
                  
                  
                  7,500
                  
                  
                  
                  15,000
                  
                  
                  
                  19,500
                  
                  
                  
                  57,375Total
                  
                  $
                  5,640,087
                  
                  
                  $
                  3,097,780
                  
                  
                  $
                  1,068,704
                  
                  
                  $
                  226,335
                  
                  
                  $
                  1,247,268
  *
                Term
      is unlimited; assumed 10 year term for this table.
 
 The
Company currently does not have any off-balance sheet special purpose
entities.  The Company had no capital leases at September 30,
2009.
 
 CAPITAL
LEVELS
 
 At September 30, 2009, National Penn,
National Penn Bank and Christiana each met the criteria for a well capitalized
institution. Management believes that, under current regulations, the Company,
National Penn Bank and Christiana will each continue to exceed the minimum
capital requirements in the foreseeable future.
  Tier
      1 Capital to
                
                Tier
      1 Capital to Risk-
                
                Total
      Capital to Risk-Average
      Assets Ratio
                
                Weighted
      Assets Ratio
                
                Weighted
      Assets RatioSept
      30,
                
                Dec.
      31,
                
                Sept
      30,
                
                Dec.
      31,
                
                Sept
      30,
                
                Dec.
      31,2009
                
                2008
                
                2009
                
                2008
                
                2009
                
                2008The
      Company
                9.00%
                
                8.50%
                
                12.46%
                
                10.65%
                
                13.72%
                
                11.85%National
      Penn Bank*
                8.02%
                
                7.90%
                
                11.00%
                
                10.00%
                
                12.26%
                
                11.19%Christiana
                7.78%
                
                10.20%
                
                12.51%
                
                11.82%
                
                13.77%
                
                13.07%"Well
      Capitalized" institution
                5.00%
                
                5.00%
                
                6.00%
                
                6.00%
                
                10.00%
                
                10.00%under
      banking regulations
  * As of
September 30, 2009 the Company’s net deferred tax asset of approximately $100
million is classified in the Company’s other assets and other
liabilities.  During the third quarter 2009 approximately $73 million
of the Company’s deferred tax asset  was reduced under regulatory
guidelines in the computation of regulatory capital ratios.  The
regulations are more restrictive than GAAP as it relates to the recognition of
the deferred tax asset related to carry forward periods.  A $60
million capital contribution from the Company to National Penn Bank was
authorized by the Company’s Board of Directors on October 27,
2009.  The pro forma Tier 1 to average asset, Tier 1 to risk-weighted
asset, and total capital to risk-weighted asset ratios are 8.02%, 11.00%, and
12.26%, respectively.
 
 Item 3. Quantitative and
Qualitative Disclosures About Market Risk.
 
 The
information presented in the Liquidity and Interest Rate Risk section of the
Management’s Discussion and Analysis of Financial Condition and Results of
Operations of this Report is incorporated herein by reference.
 
 Item 4.  Controls
and Procedures.
 
 National
Penn’s management is responsible for establishing and maintaining effective
disclosure controls and procedures.  Disclosure controls and
procedures are 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.  Disclosure controls and procedures include, without
limitation, controls and procedures designed to ensure that information required
to be so disclosed by an issuer is accumulated and communicated to the issuer’s
management, including its principal executive and principal financial officers,
or persons performing similar functions, as appropriate to allow timely
decisions regarding required disclosure.  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.
 
 National
Penn’s management is also responsible for establishing and maintaining adequate
internal control over financial reporting.  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.
    37
  National Penn considers its internal control over financial
reporting to be a subpart of its disclosure controls and
procedures.  In accordance with SEC regulations, National Penn’s
management evaluates National Penn’s disclosure controls and procedures at the
end of each quarter, while it assesses the effectiveness of its internal control
over financial reporting at the end of each year.  A determination
that internal control over financial reporting is not effective necessitates
remediation and subsequent testing for effectiveness before the next annual
formal assessment of effectiveness takes place.  Of necessity, such an
assessment precludes a finding that disclosure controls and procedures are
effective until such later time as, after remediation and subsequent testing,
internal control over financial reporting is assessed at year-end as being
effective.
  As
disclosed in management’s report on internal control over financial reporting,
filed in National Penn’s Form 10-K for the year ended December 31, 2008,
management’s assessment of the effectiveness of National Penn’s internal control
over financial reporting as of December 31, 2008 identified two control
deficiencies that, in combination, constituted a material weakness. These were:
(a) inadequate segregation of duties consistent with control objectives, and (b)
inadequate controls limiting access to National Penn’s computer systems in
retail loan accounting and other support areas. Accordingly, National Penn’s
management concluded that National Penn’s internal control over financial
reporting was not effective as of December 31, 2008.
  Due to
the material weakness identified as of December 31, 2008, which, as discussed
below, is in the remediation and testing process, National Penn’s management
concluded that National Penn’s disclosure controls and procedures were not
effective as of September 30, 2009.
  Beginning
in the fourth quarter 2008 and continuing through September 30, 2009, management
has implemented remedial changes for the identified material weakness in the
areas of system access in support and back office operations, segregation of
duties, reporting of new loans, and statement distribution and transaction
verification.  A task force of senior officers was created and is
implementing a series of guiding principles for National Penn’s risk management
program.  This task force is evaluating and redesigning, as necessary,
National Penn’s risk assessment process with the goal of creating an enhanced,
self-improving and sustainable risk and control assessment process that engages
all levels of staff, management and the Board of Directors.  The task
force has also effected changes in the areas of loan verifications and loan
maintenance, and has implemented a risk gap analysis process.  The
task force has been supported in its efforts by an independent risk management
consultant.  National Penn’s Audit Committee is reviewing these
remedial efforts as they are undertaken.  Based on the totality and
nature of the changes being made, implementation and subsequent testing for
effectiveness are expected to continue for the remainder of 2009.
  Other
than the remedial efforts discussed above, there were no changes in National
Penn’s internal control over financial reporting during the quarter ended
September 30, 2009 that materially affected, or are reasonably likely to
materially affect, National Penn’s internal control over financial
reporting.  National Penn anticipates that implementation of its
remedial plan for the aforementioned material weakness will materially improve
National Penn’s internal control over financial reporting.  However,
National Penn cannot predict the precise timing or effectiveness of any such
changes.
  There are
inherent limitations to the effectiveness of any control system.  A
control 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 is limited by available resources, and the
benefits of controls must be considered relative to their costs and their impact
on National Penn’s business model.  National Penn intends to continue
improving and refining its internal control over financial
reporting.
  PART II - OTHER
INFORMATION
  Item 1.  Legal
Proceedings.
  The
information presented in Footnote 10 to the unaudited interim financial
statements included in Part I, Item 1 of this Report is incorporated herein by
reference.
 
 Item 1A.  RISK
FACTORS
  National Penn may need to, or may be
compelled to, raise additional capital in the future, but that capital may not
be available when it is needed and on terms favorable to current
shareholders.
  Federal banking regulators require
National Penn and its banking subsidiaries to maintain adequate levels of
capital to support their operations. These capital levels are determined and
dictated by law, regulation and banking regulatory agencies. In addition,
capital levels are also determined by National Penn's management and board of
directors based on capital levels that they believe are necessary to support
National Penn's business operations. At September 30, 2009, all three capital
ratios for National Penn and each of its banking subsidiaries were above "well
capitalized" levels under current bank regulatory guidelines. To be "well
capitalized," banking companies generally must maintain a Tier 1 leverage ratio
of at least 5%, a Tier 1 risk-based capital ratio of at least 6%, and a total
risk-based capital ratio of at least 10%. However, National Penn's regulators
may require it or its banking subsidiaries to operate with higher capital
levels. For example, regulators recently have required competitor banks to
attain a Tier 1 leverage ratio of at least 8%, a Tier 1 risk-based capital ratio
of at least 10%, and a total risk-based capital ratio of at least
12%.  If regulators require National Penn to maintain capital levels
beyond its "well capitalized" level, National Penn may have to reduce assets,
seek alternative means to increase capital, or both.
   38
  If National Penn raises capital through
the issuance of additional shares of its common stock or other securities, it
would likely dilute the ownership interests of current investors
and could dilute the per share book value and earnings per share of its common
stock. Please refer to the risk factor below titled "There may be future sales
or other dilution of National Penn's equity, which may adversely affect the
market price of National Penn's common stock." Furthermore, a capital raise
through issuance of additional shares may have an adverse impact on the National
Penn's stock price. New investors may also have rights, preferences and
privileges senior to National Penn's current shareholders, which may adversely
impact its current shareholders. National Penn's ability to raise additional
capital will depend on conditions in the capital markets at that time, which are
outside of its control, and on its financial performance. Accordingly, National
Penn cannot be certain of its ability to raise additional capital on terms and
time frames acceptable to it or to raise additional capital at all. If National
Penn cannot raise additional capital in sufficient amounts when needed, its
ability to comply with regulatory capital requirements could be materially
impaired. Additionally, the inability to raise capital in sufficient amounts may
adversely affect National Penn's operations, financial condition and results of
operations.
  Deteriorating credit quality,
particularly in commercial, construction and real estate loans, has adversely
impacted National Penn and may continue to adversely impact National
Penn.
  Late in 2008, National Penn began to
experience a downturn in the overall credit performance of its loan portfolio,
as well as acceleration in the deterioration of general economic conditions.
This deterioration, as well as a significant increase in national and regional
unemployment levels and decreased sources of liquidity, are the primary drivers
of the increased stress being placed on most borrowers and is negatively
impacting their ability to repay. These conditions resulted in an increase in
National Penn's loan loss reserves at September 30, 2009.
  National Penn expects credit quality to
remain challenging and at elevated levels of risk for at least the remainder of
2009 and throughout 2010. Continued deterioration in the quality of National
Penn's credit portfolio could significantly increase nonperforming loans,
require additional increases in loan loss reserves, elevate charge-off levels
and have a material adverse effect on National Penn's capital, financial
condition and results of operations.
  The results of the internal and
independent stress tests that National Penn has conducted may not accurately
predict the impact on National Penn if the condition of the economy were to
continue to deteriorate more than assumed.
  National Penn recently conducted an
internal stress test. This stress test was based on the methodology of the tests
that were recently administered to the nation's 19 largest banks by the U.S.
Treasury in connection with its Supervisory Capital Assessment Program. For its
internal stress test, National Penn applied assumptions to estimate its credit
losses, resources available to absorb those losses and any necessary additions
to capital that would be required under a "more adverse" stress test scenario.
These assumed loss rates were not as severe as those used by the U.S. Treasury.
National Penn also reviewed a projected loan loss model made available by SNL
Financial which used an assumed loan loss rate that differed from the rate used
in National Penn's internal stress test and by the U.S Treasury.
  While National Penn believes it applied
appropriate assumptions in performing its stress test, these assumptions may
prove to be incorrect. The results of National Penn's stress test and the stress
test performed by SNL Financial may not be comparable to the results of stress
tests performed and publicly released by the U.S. Treasury, and the results of
these tests may not be the same if they had been performed by the U.S. Treasury.
Moreover, the results of the stress tests may not accurately reflect the impact
on National Penn if the economy does not improve or continues to deteriorate.
Any continued deterioration of the economy could result in credit losses
significantly higher, with a corresponding impact on National Penn's resources
and capital requirements, than those predicted by National Penn's stress
tests.
  National Penn's allowance for loan
losses may prove inadequate or be negatively affected by credit risk
exposure.
  National Penn depends on the
creditworthiness of its customers. National Penn periodically reviews the
adequacy of its allowance for loan losses, considering economic conditions and
trends, collateral values and credit quality indicators, including past
charge-off experience and levels of past due loans and nonperforming assets. As
a result of these considerations, National Penn has from time to time increased
its allowance for loan losses, most recently for the quarter ended September 30,
2009, when it recorded a provision for loan losses of $52 million. The allowance
for loan losses may not be adequate over time to cover credit losses because of
unanticipated adverse changes to the economy caused by recession, inflation,
unemployment or other factors beyond National Penn's control. Furthermore, bank
regulators may require National Penn to make a provision for loan losses or
otherwise recognize further loan charge-offs following their periodic review of
National Penn's loan portfolio, underwriting procedures and allowance for loan
losses. (See the risk factor titled "Governmental regulation, legislation and
accounting industry pronouncements could adversely affect National Penn.") If
the credit quality of National Penn's customer base materially decreases, if the
risk profile of a market, industry or group of customers changes materially, or
if the allowance for loan losses is not adequate, National Penn's business,
financial condition, liquidity, capital and results of operations could be
materially and adversely affected.
    39
  Because its operations are concentrated
in eastern Pennsylvania, National Penn's performance and financial condition may
be adversely affected by regional economic conditions and real estate
values.
  National Penn's loan activities are
largely based in 13 counties in eastern Pennsylvania. To a lesser extent,
National Penn's deposit base is also generated from this area. As a result,
National Penn's consolidated financial performance depends largely upon economic
conditions in this eastern Pennsylvania region. Deteriorating local economic
conditions during 2008 and the first three quarters of 2009 caused National Penn
to experience an increase in loan delinquencies, an increase in the number of
borrowers who defaulted on their loans and a reduction in the value of the
collateral securing their loans. A continued downturn in this regional real
estate market could further harm National Penn's financial condition and results
of operations because of the geographic concentration of loans within this
regional area and because a large percentage of its loans are secured by real
property. If there is a further decline in real estate values, the collateral
for National Penn's loans will provide less security. As a result, National
Penn's ability to recover on defaulted loans by selling the underlying real
estate will be diminished, and National Penn will be more likely to suffer
losses on defaulted loans.
  Declines in asset values may result in
impairment charges and adversely impact the value of National Penn's
investments, financial performance and capital.
  National Penn maintains an investment
portfolio that includes, but is not limited to, municipal bonds and
collateralized debt obligations. The market value of investments may be affected
by factors other than the underlying performance of the issuer or composition of
the bonds themselves, such as ratings downgrades, adverse changes in business
climate and lack of liquidity for resales of certain investment securities.
National Penn periodically, but not less than quarterly, evaluates investments
and other assets for impairment indicators. National Penn may be required to
record additional impairment charges if investments suffer a decline in value
that is considered other-than-temporary. If National Penn determines that a
significant impairment has occurred, National Penn would be required to charge
against earnings the credit-related portion of the other than temporary
impairment, which could have a material adverse effect on results of operations
in the period in which the write-off occurs.
  National Penn's investment portfolio
includes approximately $57 million in capital stock of the Federal Home Loan
Bank of Pittsburgh. This stock ownership is required of all Home Loan Bank
members as part of the overall Home Loan Bank capitalization. The Home Loan Bank
is experiencing a potential capital shortfall, has suspended its quarterly cash
dividend, and could possibly require its members, including National Penn, to
make additional capital investments in the Home Loan Bank. In order to avail
itself of correspondent banking services offered by the Home Loan Bank, National
Penn must remain a member of the Home Loan Bank. If the Home Loan Bank were to
cease operations, or if National Penn were required to write-off its investment
in the Home Loan Bank, National Penn's business, financial condition, liquidity,
capital and results of operations may be materially and adversely
affected.
  National Penn may incur impairments to
goodwill.
  At September 30, 2009, National Penn
had $556 million recorded as goodwill. National Penn reviews its goodwill at
least annually. Significant negative industry or economic trends, including the
lack of recovery in the market price of National Penn's common stock, reduced
estimates of future cash flows or disruptions to National Penn's business, could
indicate that goodwill might be impaired. National Penn's valuation methodology
for assessing impairment requires management to make judgments and assumptions
based on historical experience and to rely on projections of future operating
performance. National Penn operates in competitive environments and projections
of future operating results and cash flows may vary significantly from actual
results. If National Penn's analysis results in an impairment to its goodwill,
National Penn would be required to record a non-cash charge to earnings in its
financial statements during the period in which such impairment is determined to
exist. Any such change could have a material adverse effect on National Penn's
results of operations and our stock price.
 
   40
   National
Penn’s ability to realize its deferred tax asset may be reduced, which may
adversely impact results of operations.
  Realization of a deferred tax asset
requires the Company to exercise significant judgment and is inherently
uncertain because it requires the prediction of future
occurrences.  National Penn’s deferred tax asset may be reduced in the
future if estimates of future income or our tax planning strategies do not
support the amount of the deferred tax asset.  If it is determined
that a valuation allowance of its deferred tax asset is necessary, the Company
may incur a charge to earnings.  A valuation allowance has been
recognized for regulatory capital purposes in third quarter 2009, as disclosed
in Part I, Item 2 of this Report.
  Negative conditions in the general
economy and financial services industry may limit National Penn's access to
additional funding and adversely impact liquidity.
  An inability to raise funds through
deposits, borrowings and other sources could have a substantial negative effect
on National Penn's liquidity. National Penn's access to funding sources in
amounts adequate to finance its activities could be impaired by factors that
affect it specifically or the financial services industry in general. Factors
that could detrimentally impact National Penn's access to liquidity sources
include a decrease in the level of its business activity due to a market
downturn or adverse regulatory action against it. National Penn's ability to
borrow could also be impaired by factors that are nonspecific to National Penn,
such as severe disruption of the financial markets or negative news and
expectations about the prospects for the financial services industry as a whole
as evidenced by recent turmoil in the domestic and worldwide credit
markets.
  The impact of recently enacted
legislation, proposed legislation, and government programs intended to stabilize
the financial markets cannot be predicted at this time, and such legislation is
subject to change.
  On October 3, 2008, the Emergency
Economic Stabilization Act of 2008, or the EESA, was signed into law. Under
EESA, the U.S. Treasury has the authority to, among other things, invest in
financial institutions for the purpose of stabilizing and providing liquidity to
the U.S. financial markets. Pursuant to this authority, the U.S. Treasury
announced its Capital Purchase Program (the “CPP”), under which it is purchasing
preferred stock and warrants in eligible institutions, including National Penn,
to increase the flow of credit to businesses and consumers and to support the
economy. In accordance with the terms of the CPP, National Penn issued to the
U.S. Treasury shares of Series B Preferred Stock and a Warrant to purchase
1,470,588 shares of National Penn common stock at $15.30 a share (the
“Warrant”), for an aggregate purchase price of $150 million.  (The number
of shares subject to the Warrant was reduced to 735,294 after National Penn's
completion in the third quarter 2009 of a "qualifying equity offering" of
more than $150 million.)
  Participation in the CPP subjects
National Penn to increased oversight by the U.S. Treasury, regulators and
Congress. On February 17, 2009, the EESA was amended by the American Recovery
and Reinvestment Act of 2009, or the ARRA. The EESA, the ARRA and the rules
issued under these acts contain executive compensation restrictions and
corporate governance standards that apply to all CPP participants, including
National Penn. For example, participation in the CPP imposes restrictions on
National Penn's ability to pay cash dividends on, and to repurchase, its common
stock. With regard to increased oversight, the U.S. Treasury has the power to
unilaterally amend the terms of the CPP purchase agreement to the extent
required to comply with changes in applicable federal law and to inspect
National Penn's corporate books and records through its federal banking
regulator. In addition, the U.S. Treasury has the right to appoint two persons
to National Penn's board of directors if National Penn misses dividend payments
for six dividend periods, whether or not consecutive, on the preferred stock.
The EESA, the ARRA and the related rules subject National Penn to restrictions
on executive compensation that are complex, far-reaching, and unprecedented, and
that could materially affect National Penn's ability to attract, motivate,
and/or retain key executives and other key personnel. In addition, National Penn
is now required to submit its executive compensation program to an advisory
(non-binding) shareholder vote.
  Congress has held hearings on
implementation of the CPP and the use of funds and may adopt further legislation
impacting financial institutions that have obtained funding under the CPP or
changing lending practices that legislators believe led to the current economic
situation. Although it is unclear what, if any, additional legislation will be
enacted into law or rules will be issued, certain laws or rules may be enacted
or imposed administratively by the U.S. Treasury that could further restrict
National Penn's operations or increase governmental oversight of its businesses
and its corporate governance practices. The Special Inspector General for the
Troubled Asset Relief Program, or TARP, has requested information from CPP and
other TARP participants, including a description of past and anticipated uses of
the TARP funds and plans for addressing executive compensation requirements
under the CPP. National Penn and other CPP participants are also required to
submit monthly reports about their lending and financial intermediation
activities to the U.S. Treasury. It is unclear at this point what the
ramifications of such disclosure are or may be in the future.
  The ultimate impact that the EESA, the
ARRA and their implementing regulations, or any other legislation or
governmental program, will have on the financial markets is unknown at this
time. The failure of the financial markets to stabilize and a continuation or
worsening of current financial market conditions could materially and adversely
affect National Penn's business, results of operations, financial condition,
access to funding and the trading price of National Penn's common
stock.
   41
   Governmental regulation, legislation
and accounting industry pronouncements could adversely affect National
Penn.
  In addition to the EESA and the ARRA,
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. This regulatory scheme, which
is primarily intended to protect consumers, depositors and the government's
deposit insurance funds and to accomplish other governmental policy objectives
(e.g., combating terrorism), is expected to change—perhaps
significantly—following the Obama administration's June 2009 financial
regulatory reform proposal. In addition, National Penn is subject to changes in
accounting rules and interpretations. National Penn cannot predict what effect
any presently contemplated or future changes in financial market regulation or
accounting rules and interpretations will have on National Penn. Any such
changes may negatively affect National Penn's financial performance, its ability
to expand its products and services and/or to increase the value of its business
and, as a result, could be materially adverse to National Penn's
shareholders.
  National Penn may be required to pay
significantly higher FDIC premiums or special assessments that could adversely
affect our earnings.
  Recent bank failures have severely
depleted the FDIC’s insurance fund.  In response, the FDIC adopted a
final rule effective April 1, 2009, which changes the manner in which the FDIC’s
assessment system differentiates for risk and makes additional changes to
assessment rates and other deposit insurance assessment rules.  The
FDIC also imposed a special deposit insurance assessment of 5 basis points on
all insured institutions, which was payable on September 30, 2009, and is
considering requiring insured institutions to pay in advance their insurance
premiums for 2010-2012.  Any additional special assessments or
increased insurance premiums could adversely affect our earnings.
  Competition from other financial
institutions may adversely affect National Penn's profitability.
  National Penn's banking 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, the ability to offer a wider array
of services or more favorable pricing alternatives, as well as lower origination
and operating costs. Additionally, several of National Penn's banking
competitors are large financial institutions that have received multi-million or
multi-billion dollar infusions of capital from the U.S. Treasury or other
support from federal programs, which has strengthened their balance sheets and
enhanced their ability to withstand the uncertainty of the current economic
environment. Intensified competition from these institutions 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 banking 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 (from participation in
the CPP or otherwise), more aggressive marketing campaigns, 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 subject to less extensive regulations
than those governing National Penn's banking operations. As a result, such
non-bank competitors may have advantages over National Penn's banking and
non-banking subsidiaries in providing financial 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.
  Inability to hire or retain key
personnel could adversely affect National Penn’s business.
  National Penn's subsidiaries face
intense competition with various other financial institutions for the attraction
and retention of key personnel, specifically those who generate and maintain
National Penn's customer relationships and serve in other key operation
positions in the ears of finance, credit administration, loan functions and
information technology. These competitors may not be subject to the limitations
on executive compensation imposed under the EESA and the ARRA, may not be
subject to federal taxation, and may offer greater compensation and other
benefits, which could result in the loss of potential and/or existing key
personnel, including the loss of potential and/or existing substantial customer
relationships.
   42
  Variations in interest rates may
negatively affect National Penn's financial performance.
  Changes in interest rates may reduce
profits. The primary source of income for National Penn currently is the
differential, or the net interest spread, between the interest earned on loans,
securities and other interest-earning assets, and the 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 re-pricing 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 repay their obligations. In a declining interest rate environment,
National Penn may be unable to re-price deposits downward in the same magnitude
and/or with the same timing as the movement in its interest-sensitive assets.
Accordingly, changes in levels of market interest rates, whether upward or
downward, could materially adversely affect National Penn's net interest spread,
loan origination volume, asset quality and overall profitability.
  National Penn is subject to certain
risks in connection with its strategy of growing through mergers and
acquisitions.
  Mergers and acquisitions have
contributed significantly to National Penn's growth in the past 18 years, and
continue to be a key component of its longer-term business model. Accordingly,
it is possible that National Penn could acquire other financial institutions,
financial service providers or branches of banks in the future. National Penn's
ability to engage in future mergers and acquisitions depends on its ability to
identify suitable merger partners, finance and complete such transactions on
acceptable terms and at an acceptable price, and its ability to receive the
necessary regulatory approvals and, when required, shareholder approval.
National Penn's success also depends on, among other things, its ability to
realize anticipated cost savings and revenue enhancements from acquisitions and
to combine the businesses of the acquired companies in a manner that permits
growth without materially disrupting existing customer relationships or
resulting in decreased revenues due to loss of customers. If National Penn is
not able to successfully achieve these objectives, the anticipated benefits of
such acquisitions may not be realized fully or at all or may take longer to
realize than expected. Additionally, if the integration efforts following
acquisitions are not successfully managed, the failure of these integration
efforts could result in loan losses, deposit attrition, operating costs, loss of
key employees, disruption of National Penn's ongoing business or inconsistencies
in standards, controls, procedures and policies that adversely affect National
Penn's ability to maintain relationships with customers and employees or to
achieve the anticipated benefits of such acquisitions or result in unanticipated
losses.
  If National Penn's information systems
are interrupted or sustain a breach in security, those events may negatively
affect National Penn's financial performance and reputation.
  In conducting its business, National
Penn relies heavily on its information systems. Maintaining and protecting those
systems is difficult and expensive, as is dealing with any failure, interruption
or breach in security of these systems, whether due to acts or omissions by
National Penn or by a third party and whether intentional or not. Any such
failure, interruption or breach could result in failures or disruptions in
National Penn's customer relationship management, general ledger, deposit, loan
and other systems. The policies, procedures and technical safeguards put in
place by National Penn to prevent or limit the effect of any failure,
interruption or security breach of its information systems may be insufficient
to prevent or remedy the effects of any such occurrences. The occurrence of any
failures, interruptions or security breaches of National Penn's information
systems could damage National Penn's reputation, result in a loss of customer
business and data, subject National Penn to additional regulatory scrutiny, or
expose National Penn to civil litigation and possible financial liability, any
of which could have a material adverse effect on National Penn's financial
condition and results of operations.
  If National Penn's information
technology is unable to keep pace with its growth or industry developments,
National Penn's financial performance may suffer.
  Effective and competitive delivery of
National Penn's products and services is increasingly dependent upon information
technology resources and processes, both those provided internally as well as
those provided through third party vendors. In addition to better serving
customers, the effective use of technology increases efficiency and enables
National Penn to reduce costs. National Penn's future success will depend, in
part, upon its ability to address the needs of its customers by using technology
to provide products and services to enhance customer convenience, as well as to
create additional efficiencies in its operations. Many of National Penn's
competitors have greater resources to invest in technological improvements.
Additionally, as technology in the financial services industry changes and
evolves, keeping pace becomes increasingly complex and expensive for National
Penn, and National Penn's need to attract, retain and motivate qualified
personnel becomes increasingly critical, particularly as National Penn may
complete future acquisitions and enter new markets. There can be no assurance
that National Penn will be able to effectively implement new technology-driven
products and services, which could reduce its ability to compete
effectively.
   43
  National Penn's internal control
systems are inherently limited.
  National Penn's system of internal
controls, disclosure controls and corporate governance policies and procedures
is inherently limited. As of December 31, 2008, National Penn had identified
certain control deficiencies that, in combination, constituted a material
weakness. The inherent limitations of National Penn's system of internal
controls include the realities that judgments in decision-making can be faulty,
breakdowns can occur because of simple errors or mistakes and controls can be
circumvented by the individual acts of some persons or by collusion of two or
more people. The design of any system of controls is based in part upon certain
assumptions about the likelihood of future events, and any design may not
succeed in achieving its stated goals under all potential future conditions.
Because of the inherent limitation of a cost-effective control system,
misstatements due to error or fraud may occur and may not be detected, which may
have an adverse effect on National Penn's business, results of operations or
financial condition. Additionally, any plans of remediation for any identified
weaknesses may be ineffective in improving National Penn's internal
controls.
  There may be future sales or other
dilution of National Penn's equity, which may adversely affect the market price
of National Penn's common stock.
  On September 18, 2009, National Penn
completed an underwritten public offering of 30,705,000 shares of common
stock.  In connection with the offering, National Penn entered into a
Lock-Up Agreement with the underwriters, Sandler O'Neill & Partners, L.P,
which restricts National Penn’s ability to issue additional common shares,
including any securities that are convertible into or exchangeable for, or that
represent the right to receive, common shares for a period of 60 days after
September 9, 2009.  This 60 day restricted period will be
automatically extended if (1) during the last 18 days of the 60-day restricted
period, National Penn issues an earnings release or material news or a material
event relating to National Penn occurs or (2) prior to the expiration of the
60-day restricted period, National Penn announces that it will release earnings
results or becomes aware that material news or a material event will occur
during the 16-day period beginning on the last day of the 60-day restricted
period, in which case the restricted period will continue to apply until the
expiration of the 18-day period beginning on the date on which the earnings
release is issued or the material news or material event related to
us.
  Except pursuant to the Lock-Up
Agreement as described above, National Penn is not restricted from issuing
additional common shares, including any securities that are convertible into or
exchangeable for, or that represent the right to receive, common shares.
National Penn is currently authorized to issue up to 250 million common shares,
of which 125,658,738 shares were outstanding as of September 30, 2009, and up to
one million shares of preferred stock, none of which shares are outstanding
other than 150,000 shares of Series B Preferred Stock, which National Penn
issued to the U.S. Treasury in connection with participation in the CPP. In
addition, as of September 30, 2009, 3,064,913 shares are available for purchase
under National Penn's Dividend Reinvestment and Stock Purchase Plan and its
Employee Stock Purchase Plan. The Employee Stock Purchase Plan allows employee
shareholders to purchase shares of National Penn common shares at a 10% discount
from market value. As of September 30, 2009, 10,992,016 shares are issuable upon
the vesting of restricted stock units and/or exercise of stock options that have
been, or stock options, stock appreciation rights, stock awards and restricted
stock that may be, issued under National Penn's equity compensation plans. The
U.S. Treasury may, at its option, exercise its Warrant to purchase 735,294 of
National Penn's common shares (the number of shares remaining subject to the
Warrant after National Penn’s completion in the third quarter 2009 of a
“qualifying equity offering” of more than $150 million). Should the U.S.
Treasury exercise its Warrant or should National Penn experience strong
participation in the Employee Stock Purchase Plan or the Dividend Reinvestment
and Stock Purchase Plan, the issuance of the required shares of common stock
will dilute the ownership of National Penn's shareholders and could depress our
stock price. National Penn also has the ability to issue an unlimited amount of
securities including common stock, preferred stock, debt securities, depositary
shares and securities warrants, from time to time at prices and on terms to be
determined at the time of sale under an active shelf registration statement,
which it filed with the SEC on November 7, 2008. National Penn's board of
directors has authority, without action or vote of the shareholders, to issue
all or part of the authorized but unissued shares. These authorized but unissued
shares could be issued on terms or in circumstances that could dilute the
interests of other shareholders.
  In addition, National Penn may decide
to repurchase the Series B Preferred Stock issued to the U.S. Treasury in
connection with National Penn's participation in the CPP. To repurchase the
preferred stock, National Penn is required to obtain the approval of National
Penn's primary federal regulator which may require National Penn to raise
additional capital prior to repurchasing the Series B Preferred Stock. Should
National Penn choose to raise capital by selling shares of common stock for any
reason, including, without limitation, for the purpose of repurchasing its
Series B Preferred Stock or for increasing its regulatory capital, the issuance
would have a dilutive effect on National Penn's other shareholders and could
have a material negative effect on the market price of National Penn's common
stock.
   44
  National Penn relies on dividends it
receives from its subsidiaries, may further reduce or eliminate the cash
dividends on its common stock, and is subject to restrictions on its ability to
declare or pay dividends and repurchase shares of common stock.
  As a bank holding company, National
Penn's ability to pay dividends depends primarily on its receipt of dividends
from its direct and indirect subsidiaries. Its principal bank subsidiary,
National Penn Bank, is National Penn's primary source of dividends. Dividend
payments from National Penn Bank and Christiana Bank & Trust Company 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 and Christiana Bank & Trust Company to pay dividends is also
subject to profitability, financial condition, regulatory capital requirements,
capital expenditures and other cash flow requirements. As of September 30, 2009,
National Penn Bank had no ability to pay dividends to National Penn without
prior regulatory approval, while Christiana Bank & Trust Company had the
ability to pay $860,000 in dividends to National Penn without prior regulatory
approval. There is no assurance that National Penn Bank, Christiana Bank &
Trust Company and/or National Penn's other subsidiaries will be able to pay
dividends in the future.
  In October 2009, National Penn's board
of directors approved a fourth quarter 2009 cash dividend of $0.01 per share,
which was a reduction from the $0.05 per share amount paid in the third quarter
of 2009. The board reduced the common stock cash dividend to preserve capital
and strengthen National Penn's tangible common equity levels. There can be no
assurance that National Penn will pay dividends to its shareholders in the
future, or if dividends are paid, that National Penn will increase its dividend
to historical levels or otherwise. National Penn's ability to pay dividends to
its shareholders is not only subject to limitations imposed by the terms of the
CPP, but also to guidance issued by the Board of Governors of the Federal
Reserve System, or the Federal Reserve. Under this guidance, bank holding
companies like National Penn are advised to consult in advance with the Federal
Reserve before declaring dividends, and to strongly consider reducing, deferring
or eliminating dividends, in certain situations—for example, when declaring or
paying a dividend that would exceed earnings for the fiscal quarter for which
the dividend is being paid, or when declaring or paying a dividend that could
result in a material adverse change to the organization's capital structure.
Importantly, this Federal Reserve guidance is relevant not only to dividends
paid on National Penn's common stock, but also to those payable in respect of
National Penn's preferred stock held by the U.S. Treasury. National Penn's
failure to pay dividends on its preferred stock or common stock could have a
material adverse effect on its business, operations, financial condition, access
to funding and the market price of its common stock.
  Under the terms of National Penn's
purchase agreement with the U.S. Treasury pursuant to which National Penn issued
the Series B Preferred Stock and the Warrant, National Penn's ability to declare
or pay dividends on any of its stock is restricted. Specifically, National Penn
may not declare dividend payments on common, junior preferred or pari passu preferred stock if
it is in arrears on the dividends on the Series B Preferred Stock. Further,
National Penn may not increase the dividends on its common stock above $0.17 per
share, without the U.S. Treasury's approval until December 12, 2011 unless all
of the Series B Preferred Stock has been redeemed or transferred.
  National Penn's ability to repurchase
its common stock is also restricted under the terms of the purchase agreement
with the U.S. Treasury. The U.S. Treasury's consent generally is required for
National Penn to make any stock repurchases until December 12, 2011 unless all
of the Series B Preferred Stock has been redeemed or transferred. Further,
common, junior preferred or pari passupreferred shares
may not be repurchased if National Penn is in arrears on the Series B Preferred
Stock dividends.
  There can be no assurance that National
Penn will repurchase the Series B Preferred Stock and the Warrant or that
National Penn's regulators would approve such redemption and
repurchase.
  National
Penn has not determined if or when it will seek the approval of its regulators
to repurchase the Series B Preferred Stock and the Warrant. Such repurchases are
subject to regulatory approval. There can be no assurance when or if the Series
B Preferred Stock and Warrant can be repurchased or what the redemption price
for the Warrant will be. Until such time as the Series B Preferred Stock and the
Warrant is repurchased, National Penn will remain subject to the terms and
conditions set forth in the purchase agreement with the U.S. Treasury, the
Series B Preferred Stock and the Warrant, which, among other things, require
National Penn to obtain regulatory approval to pay quarterly dividends on its
common stock in excess of $0.17 per share and, with some exceptions, to
repurchase its common stock. Further, National Penn's continued participation in
the CPP subjects it to increased regulatory and legislative oversight. See the
risk factor titled "The impact of recently enacted legislation, proposed
legislation, and government programs intended to stabilize the financial markets
cannot be predicted at this time, and such legislation is subject to
change.”
  A Warning About
Forward-Looking Information
  This
Report, including information incorporated by reference in this Report, contains
forward-looking statements about National Penn and its
subsidiaries.  In addition, from time to time, National Penn or its
representatives may make written or oral forward-looking statements about
National Penn and its subsidiaries.  These forward-looking statements
are intended to be covered by the safe harbor for forward-looking statements
provided by the Private Securities Litigation Reform Act of
1995.  Forward-looking statements are not statements of historical
fact, and can be identified by the use of forward-looking terminology such as
“believe,” “expect,” “may,” “will,” “should,” “project,” “plan,” “seek,”
“target,” “intend” or “anticipate” or the negative thereof or comparable
terminology.  Forward-looking statements include discussions of
strategy, financial projections, guidance and estimates (including their
underlying assumptions), statements regarding plans, objectives, expectations or
consequences of various transactions, and statements about the future
performance, operations, products and services of National Penn and its
subsidiaries. National Penn cautions its shareholders and other readers not to
place undue reliance on such statements.
   45
  National
Penn’s businesses and operations are and will be subject to a variety of risks,
uncertainties and other factors. Consequently, 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
risk factors in National Penn’s Annual Report on Form 10-K for the year ended
December 31, 2008, as updated in this Report, as well as the
following:
  ·
              National
      Penn’s branding and marketing initiatives may not be effective in building
      name recognition and customer awareness of National Penn’s products and
      services.
  ·
              National
      Penn may be unable to differentiate itself from its competitors by a
      higher level of customer service, as intended by its business strategy and
      other marketing initiatives.
  ·
              Expansion
      of National Penn’s product and service offerings may take longer, and may
      meet with more effective competitive resistance from others already
      offering such products and services, than
      expected.  Additionally, new product development by new and
      existing competitors may be more effective, and take place more quickly,
      than expected.
  ·
              National
      Penn may be unable to attract, motivate, and/or retain key executives and
      other key personnel due to intense competition for such persons, National
      Penn’s cost saving strategies, increased governmental oversight or
      otherwise.
  ·
              Growth
      and profitability of National Penn’s non-interest income or fee income may
      be less than expected, particularly as a result of current financial
      market conditions.
  ·
              General
      economic or business conditions, either nationally or in the regions in
      which National Penn does business, may continue to deteriorate or be more
      prolonged than expected, resulting in, among other things, a deterioration
      in credit quality, a reduced demand for credit, or a decision by National
      Penn to reevaluate staffing levels or to divest one or more lines of
      business.
  ·
              In
      the current environment of increased investor activism, including hedge
      fund investment policies and practices, shareholder concerns or actions
      due to stock price fluctuations may require increased management/board
      attention, efforts and commitments, which could require a shift in focus
      from business development and
operations.
  ·
              Current
      stresses in the financial markets may inhibit National
      Penn's ability to access the capital markets or obtain financing on
      favorable terms.
  ·
              Repurchase
      obligations with respect to real estate mortgages sold in the secondary
      market could adversely affect National Penn’s
  earnings.
  ·
              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, employee,
      director or other associated individual or entity whether legally
      justified or not, could adversely affect National Penn’s reputation and
      business.
  ·
              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
  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 risk factors and cautionary statements
contained in National Penn’s Form 10-K referenced above and 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.
   46
  Item
2.  Unregistered Sales of Equity Securities and Use of
Proceeds.
 
 There were no repurchases by National
Penn of its common stock at any time during the quarter ended
 September
30, 2009.  National Penn is not permitted to repurchase shares of its
stock under a stock repurchase plan until the earlier of December 12, 2011 or
the date on which the U.S. Treasury no longer holds National Penn’s senior
preferred stock.
 
 Item 3.  Defaults
Upon Senior Securities.
 
 None.
 
 Item
4.  Submission of Matters to a Vote of Security
Holders.
 
 During the quarter ended September 30,
2009, no matters were submitted to a vote of National Penn
shareholders.
 
 Item 5.  Other
Information.
 
 None.
 
 Item
6.  Exhibits.
 
 1.1
              Underwriting
      Agreement, dated September 9, 2009, between National Penn Bancshares, Inc.
      and Sandler O’Neill Partners, L.P., as representative of the several
      underwriters, JP Morgan Securities, Inc. and Keefe, Bruyette and Woods,
      Inc. (Incorporated by reference to Exhibit 1.1 to National Penn’s Report
      on Form 8-K dated September 15, 2009, as filed on September 15,
      2009.)3.1
              Statement
      with Respect to Shares, of National Penn Bancshares, Inc. (Incorporated by
      reference to Exhibit 3.1 to National Penn’s Report on Form 8-K dated
      October 27, 2009, as filed on    November 2,
      2009.)3.2
              Bylaws,
      as amended, of National Penn Bancshares, Inc. (Incorporated by reference
      to Exhibit 3.2 to National Penn’s Report on Form 8-K dated October 27,
      2009, as filed on November 2, 2009.)10.1
              National
      Penn Bancshares, Inc. Amended and Restated Dividend Reinvestment and Stock
      Purchase Plan (Incorporated by reference to Exhibit 10.1 to National
      Penn’s Report on Form 8-K dated   July 22, 2009, as filed
      on July 22, 2009.)10.2
              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  July 22, 2009, as filed on July 22,
      2009.)10.3
              Employment
      Agreement dated as of August 12, 2009 among National Penn Bancshares,
      Inc., National Penn Bank and Michael J. Hughes* (Incorporated by reference
      to Exhibit 10.1 to National Penn’s Report on Form 8-K dated August 12,
      2009 (as filed on August 12, 2009).10.4
              TARP
      Restriction Agreement dated October 30, 2009 between National Penn
      Bancshares, Inc. and Bruce G. Kilroy* (Incorporated by reference to
      Exhibit 10.1 to National Penn’s Report on Form   8-K dated
      November 3, 2009 (as filed on November 3, 2009).10.5
              TARP
      Restriction Agreement dated November 2, 2009 between National Penn
      Bancshares, Inc. and Paul W. McGloin* (Incorporated by reference to
      Exhibit 10.2 to National Penn’s Report on Form 8-K dated November 3, 2009
      (as filed on November 3, 2009).31.1
              Certification of President 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 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.   47
   32.1
              Certification of President and Chief Executive Officer
      of National Penn Bancshares, Inc., pursuant to Commission Rule 13a-14(b)
      and 18 U.S.C. Section 1350, as adopted pursuant to Section 906 of the
      Sarbanes-Oxley Act of 2002.  (Furnished, not
      filed.)32.2
              Certification of  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.
 
 
  48
   
 
 SIGNATURES
 
 
 Pursuant to the requirements of Section
13 of the Securities Exchange Act of 1934, the Registrant has caused this report
to be signed on its behalf by the undersigned thereunto duly
authorized.
 
 
 NATIONAL
      PENN BANCSHARES, INC.(Registrant)Date:
              November
      6, 2009
              
              By:
              /s/
      Glenn E. MoyerName:
              Glenn
      E. MoyerTitle:
              President
      and CEODate:
              November
      6, 2009
              
              By:
              /s/
      Michael J. HughesName:
              Michael
      J. HughesTitle:
              Chief
      Financial Officer