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.

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.

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.

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
                                            September       September
(dollars in thousands)                      30, 2009         30, 2008
Net Income (loss) available to common
shareholders                               $   (73,084 )   $     68,035
After tax unrealized fair market value
gain on NPB
Capital Trust II Preferred Securities            5,262           (3,569 )
After tax (gain) loss on investment
securities                                       2,046             (429 )
After tax other-than-temporary
impairment charge
on synthetic CDO investment                     64,757           13,000
After tax insurance proceeds                    (2,618 )              -
After tax special FDIC assessment                3,006                -
Core net income                            $      (631 )   $     77,037

Basic earnings (loss) available to
common shareholders                        $     (0.81 )   $       0.90
After tax unrealized fair market value
gain on NPB
Capital 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 charge
on synthetic CDO investment                       0.72             0.17
After 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                   2008
Return 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
acquisition
related average goodwill and
intangibles:
Average shareholders' equity               $       1,209,042       $       973,495
Average goodwill and intangibles                    (590,736 )            (532,771 )
Average tangible equity                    $         618,306       $       440,724
Average common equity                              1,064,492               973,495 *
Average tangible common equity                       473,756               440,724

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.

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       12/31/05

Specific reserves                 $  13,128     $    5,086     $      613     $    1,307     $    1,716
Allocated reserves                  110,916         72,368         54,162         56,787         52,189
Unallocated reserves                  1,446          6,552            122            212          2,159
Total Allowance for Loan and
Lease Losses                      $ 125,490     $   84,006     $   54,897     $   58,306     $   56,064

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        12/31/05

Nonperforming loans               $   120,120     $    35,586     $    15,285     $     8,648     $    12,144
Nonperforming loans to total
loans                                    1.94 %          0.56 %          0.39 %          0.24 %          0.40 %
Delinquent loans                  $    30,885     $    20,782     $     7,041     $     8,196     $     3,399
Delinquent loans to total loans          0.50 %          0.33 %          0.18 %          0.23 %          0.11 %
Classified loans                  $   483,163     $   196,349     $    68,970     $    66,390     $    74,756
Classified 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     $   374,478
Classified 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).

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                   2008
Restructured loans                                           $           589        $          623
Nonaccrual loans and leases                                          116,418                31,972
  Impaired and restructured loans                                    117,007                32,595

Loans past due 90 or more days as to interest or principal             3,113                 2,991
  Total non-performing loans                                         120,120                35,586
Other real estate owned                                                  826                 1,552
  Total non-performing loans and ORE                         $       120,946        $       37,138

Total loans and leases, including loans held for sale        $     6,199,684        $    6,315,874

Average total loans and leases                               $     6,337,201        $    5,936,805

Allowance for loan and lease losses                          $       125,490        $       84,006

Allowance 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 %

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 Ended
                                              September 30,                       September 30,
(dollars in thousands)                    2009              2008             2009               2008
Net charge-offs                       $     65,541       $    11,083     $     24,823       $      4,822

Net 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 . . .