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National Penn Bancshares, Inc. (NASDAQ:NPBC)

Q4 2007 Earnings Call

January 22, 2008, 1:00 pm ET

Executives

Michelle Debkowski – Investor Relations Officer

Glenn E. Moyer - President and Chief Executive Officer

Michael R. Reinhard - Chief Financial Officer

Operator

Good day ladies and gentlemen. All sites are now online in a listen-only mode. I will now turn the program over to your moderator for today, the investor relations officer for National Penn, Michelle Debkowski. Go ahead please.

Michelle Debkowski

Thank you and good afternoon. We would like to welcome you to National Penn Bancshares 2007 earnings webcast. We are glad that you are able to join us.

Questions will be accepted during the webcast via email. Please use the email button located on the conference call screen to ask your question. Due to time constraints we may not be able to get to all of your emails. Additionally, as we review questions received we may combine questions that raise similar issues or can otherwise be combined for comments.

As part of our webcast presentation you will see that there are slides with financial highlights available to you for your independent review. The presentation and slides will be available on our website as well as filed on Form 8-K with the Securities and Exchange Commission following our webcast.

This presentation contains forward-looking information that is intended to be covered by the Safe Harbor for forward-looking statements provided by the Private Securities Litigation Reform Act of 1995. Many of these factors are listed on the slides on your screen. I will give you a moment to review the slides.

I would now like to turn today’s presentation over to Glenn E. Moyer, President and Chief Executive Officer of National Penn Bancshares. Glenn?

Glenn E. Moyer

Thank you, Michelle. Joining me today is Michael Reinhard, Chief Financial Officer of National Penn Bancshares. I will start the call today by reviewing highlights from our 2007 earnings release, which is available on the investor relations section of our website. Earlier today we included the press release and our report on Form 8-K, that we filed with the Securities and Exchange Commission.

Mike Reinhard will provide an overview of our financials. I will review our loan growth and credit quality, comment on our overall results for 2007, and then wrap up with some concluding comments.

Beginning with financial highlights, our 2007 results, under accounting principals generally accepted in the United States referred to as GAAP reflect record high earnings of $65.23 million, a $1.12 million increase over GAAP earnings for 2006. This represents our 30th consecutive year of record net income as measured by both net income and earnings per share.

On a per share basis, we earned $1.31 per diluted share in 2007, a $0.02 per share increase over 2006 diluted earnings per share. Growth in 2007 net interest income as compared to 2006 net interest income contributed to our profit performance, as did increases in some key fee income areas.

We provided funding in 2007 for our loan loss reserve of $7.83 million, resulting in a loan loss reserve of 1.42% of total loans and leases at December 31, 2007. I will provide additional details on the loan portfolio later in this webcast.

I will now turn the presentation over to Mike Reinhard for a further discussion of our 2007 financial results.

Michael R. Reinhard

Thank you and good afternoon. Let me begin by noting that any reference to per share results are figured to have been restated for the 3% stock dividend issued September 28, 2007.

I would also like to note that this presentation contains a non-GAAP financial measure, return on average tangible equity. Due to a number of acquisitions in recent years, purchase accounting rules have negatively impacted our GAAP return on equity. The non-GAAP return on tangible equity ratio excludes the impact of acquisition related goodwill and intangibles as used by National Penn’s management for comparative purposes in its analysis of the company’s performance. A reconciliation of our GAAP and non-GAAP return on equity ratios is included in our presentation today for your review.

Net income for the year 2007 was a record $65.23 million or $1.31 per diluted share, compared to prior year net income of $64.11 million or $1.29 per diluted share. Net income for fourth quarter 2007 was $16.71 million or $0.34 per diluted share, compared to net income of $16.37 million or $0.33 per diluted share for the same period a year ago.

Our 2007 earnings produced a return on average assets of 1.16% and a return on average equity of 11.95% as compared to 1.24% and 12.64%, respectively in 2006. The decline, particularly in return on average equity, was as expected due to the increased average equity resulting from the company’s strategy of gradually building its tangible equity to tangible assets ratio.

Net income return on average tangible equity was 24.52% in 2007 compared to 27.06% in 2006. This non-GAAP financial measure is computed by dividing annualized net income by average equity that is reduced by average acquisition related goodwill and intangibles.

Our net interest margin increased in the fourth quarter to 3.41% from 3.35% in the third quarter of 2007. For the year 2007 net interest margin was 3.39% compared to 3.55% during 2006. As with many others in our industry, National Penn’s margin has felt the impact of relatively flat yield curve which currently provides for little spread between deposit rates and fixed loan rates. If there is any good news involving net interest margin, it’s that we have seen samplization throughout 2007 and even a slight increase in margin as noted above compared to third quarter 2007. As well as an increase compared to the 3.35% net interest margin recorded for the fourth quarter 2006.

Our growth in 2007 compensated somewhat for the reduced margin when compared to the full year 2006, resulting in increased net interest income on a full tax equivalent basis for 2007, that is $6.53 million higher than net interest income for 2006. For the fourth quarter, net interest income on a full tax equivalent basis was $44.88 million in 2007, compared to $40.69 million for fourth quarter 2006.

A provision for loan losses of $3.8 million was made in fourth quarter 2007, as compared to a provision of $840,000 for the fourth quarter of 2006. The total provision for loan losses of $7.83 million in 2007 represents a $5.29 million, or 208% increase in the provision from 2006.

Fourth quarter 2007 net charge-offs of $5.2 million were $3.43 million more than the $1.77 million net charge-offs in the fourth quarter of 2006. Total net charge-offs for 2007 of $11.24 million compared to $3.19 million of net charge-offs in 2006. Glenn will discuss credit quality in more detail in his remarks.

Non-interest income increases were positive contributors to overall earnings growth when compared to last year’s fourth quarter. Non-interest income of $20.45 million in this year’s fourth quarter is up $1.05 million, or 5.41% as compared to last year’s fourth quarter.

Excluding non-recurring gains, totaling $1.34 million on the sale of two bank properties realized in the fourth quarter 2006, non-interest income would have been up $2.39 million or 13.26% for the same period in 2006.

Wealth management income continued to contribute above expectations in the fourth quarter, and was up $820,000, or 21.66% over the fourth quarter of 2006. The growth in this business segment’s income has been strong across all operating wealth management units.

Quarterly service charges and fees were also up slightly over the prior year by $78,000 or 1.76%. Fourth quarter 2007 cash management and electronic banking fees were up $334,000 or 16.43% over fourth quarter 2006 fees.

Income from bank owned life insurance referred to as BOLI was down $27,000 compared to fourth quarter 2006, as lowering interest rates resulted in reduced yields on this portfolio. Our insurance agency revenue was down $255,000 from the prior year’s quarterly revenue.

Not unexpectedly, and reflecting the industry wide slow down in residential mortgage lending over this past year, mortgage banking revenue was down $517,000 from last year’s fourth quarter. Non-interest income for the fourth quarter 2007 also includes $2.55 million, representing our share of income from equity method partnership investments as well as $1.59 million representing a gain on NTD Capital Trust Two under the Fair Value Option Guidelines of FAS 159 and FAS 157 as early adopted for this financial instrument.

In the fourth quarter of 2006, income from equity method partnership investments amounted to $2.67 million, $127,000 higher than the amount reported in this year’s fourth quarter. Total non-interest expense for the fourth quarter increased $2 million or 5.74% over the same period last year, included as a reduction of non-interest expense for the fourth quarter 2006 is a net recovery of $1.33 million as a result of a final insurance payment on a previously reported loan fraud. The receipt of this final insurance settlement was disclosed in a Form 8-K filed on August 31, 2006. Adjusting for this non-recurring item, total non-interest expense for the fourth quarter would have increased by $674,000 or 1.86% over the fourth quarter 2006. This modest increase is comprised of higher salaries and benefits expense as well as increased premises and equipment expense.

Regarding the balance sheet, total assets grew 6.83% during the past year to $5.82 billion of December 31, 2007. Growth in loans and leases over the past year was $243.32 million or 6.7%. Glenn will have a further discussion regarding loans in his comments.

Total deposits increased by $120.53 million or 3.15% over the past year to $3.95 billion. At December 31, 2007, National Penn was in compliance with all applicable regulatory capital requirements. National Penn and National Penn Bank each are considered well capitalized as defined by banking regulators. We target our tangible equity to tangible assets to be a minimum of 5%. At December 31st, our ratio stood at 5.16%, up from 5.01% at December 31, 2006. We are pleased that we have been able to gradually build our tangible equity in 2007 and will continue to actively manage this ratio during 2008, particularly surrounding the two acquisitions closing in early 2008 and their overall positive impact on this ratio.

As previously mentioned 2007 represent National Penn’s 30th consecutive year of increased earnings and 30th consecutive year of increased cash dividends. It also marks the 30th consecutive year of stock dividends or splits on National Penn stock.

I would now like to turn the presentation back to Glenn Moyer.

Glenn E. Moyer

Thank you, Mike. I would like to take a few moments to comment on our loan growth and our overall credit quality. With respect to our loan portfolio at year end 2007, total loans and leases outstanding are $3.88 billion, representing a 6.7% rate of growth during the past year. Loan growth in 2007 was affected by the $26.7 million securitization of adjustable rate mortgages which provides a 7.43% rate of loan growth for 2007 when adjusted for this transaction. These loans now exist as a mortgage backed security in the company’s investment portfolio providing increased liquidity and [pledging] availability.

Loan growth during fourth quarter 2007 was reflected most notably in the areas of commercial business and commercial real estate lending which increased $49.64 million or 3.16%, and $30.37 million or 2.4% respectively. These loan growth percentages are non-annualized. At December 31, 2007, our commercial loan categories represented 75.28% of our total loans, as compared to 72.74% at December 31, 2006. We remain comfortable with this overall loan mix but as we go forward we will continue to evaluate the appropriateness of this mix by loan type and make adjustments as deemed appropriate.

The level of non-performing assets plus loans over 90 days delinquent category increased compared to December 31, 2006, specifically this number as of December 31, 2007 is $15.29 million versus $9.94 million at December 31, 2006. Despite the year-over-year increase, we believe that our ratio of non-performing assets to total loans of 0.39% is in line with or better than industry averages.

We also believe we remain appropriately positioned in our overall loan and lease loss reserve at $54.9 million or 1.42% of total loans and leases as of December 31, 2007 after fourth quarter net charge-offs of $5.2 million. Based on the current reserve, our coverage ratios of non-performing assets is 359.2%. This compares to a coverage ratio of 586.6% of December 31, 2006 and 461.7% at December 31, 2005. Based on the strength of these coverages, our review of overall credit quality indicators, and our on-going loan monitoring processes, we feel we have adequately provided for loan and lease losses during 2007. This is a dynamic process and we will continue to evaluate the appropriate level of provision on a quarterly basis.

It is important to note that National Penn’s increase in non-performing assets and charge-offs is not a retail loan or residential mortgage issue nor are there any repercussions from subprime exposure. The increases are not out of the ordinary for a slowing economy that is experiencing significantly higher fuel costs and slower capital spending. For National Penn, the non-performing loan and charge-off increases have been driven by CI credits as well as one larger commercial real estate credit in the fourth quarter. Our loan portfolio remains in generally good condition and we will continue to monitor our portfolio’s risks and concentration exposure diligently.

We are pleased to announce that the acquisition of Christiana Bank & Trust Company was completed on January 4, 2008. Christiana Bank & Trust brings significant opportunities to profitably serve our expanding client base, particularly in the wealth management area.

Our merger with KNBT Bancorp, Inc. is on track for an early 2008 settlement. Our integration teams are working hard and looking forward with enthusiasm to our future together.

Together, these two significant mergers when combined with National Penn’s organic growth momentum will allow for a meaningful transformation of the new National Penn [webcast skip and distortion] local financial services company for the needs of our retail and commercial customers as well as our shareholders.

We will continue our focus on diversified earnings growth and cost containment efforts that will allow us to build shareholder value through these challenging economic times. We thank you for your continued interest in National Penn.

This ends our planned remarks and we will now address questions that have been received during the course of our discussion or a bit earlier. Michelle?

Question-and-Answer Session

Michelle Debkowski

Thank you, Glenn. We had several questions presented during the webcast and Mike I will begin with you.

Mike, what is your outlook for the net interest margin given today’s rate cut?

Michael R. Reinhard

Our interest rate risk model generally shows liabilities repricing to a greater extent than assets. That’s a good thing given today’s declining rate environment. Our concern, though, is that in the current competitive market for deposits, we have not been able to move deposit rates downward to the extent that we assume in our model. So the overall positive environment is being muted somewhat by the challenging deposit market.

Michelle Debkowski

Mike, can you comment on the increase in other expenses?

Michael R. Reinhard

As we mentioned in the presentation, excluding the insurance payment in 2006, year-over-year expenses were up only 1.86%. However on a linked quarter basis, fourth quarter expenses were up by a wider margin due primarily to merger related expenses.

Michelle Debkowski

Thank you, Mike.

Glenn, a few questions for you concerning credit, has your watch list increased over the past quarter?

Glenn E. Moyer

No, as a percent of total loans the watch list credits were flat.

Michelle Debkowski

How was the construction lend portfolio performing, in other words the percent of non-performing assets?

Glenn E. Moyer

We had only one non-performing asset at fiscal year end ’07 that was from our construction portfolio. That represented $3.2 million of the total $15.3 million in net non-performing assets. Overall we do continue to note a slowing sales pace in the residential construction credits in our portfolio.

Michelle Debkowski

Are there any concentrations such as construction on the watch list or in non-performing assets?

Glenn E. Moyer

Let me just try and share a couple of numbers here that might be helpful in this question. Commercial real estate non-performers equal 21.6% of total non-performing assets compared to 23% of total relationships. As a percent of total watch loans, this again is commercial real estate, as a percent of total watch loans they are 15.64%.

Michelle Debkowski

Glenn, a couple of questions concerning our stock, a question came in from an individual that said, “I reported to the bank that illegal naked short-selling was taking place in the bank’s stock. What did you find out? Could it have been the cause of the stock’s drop from 21 to 14, representing a third drop in the price?”

Glenn E. Moyer

Michelle, I made a couple of comments. Short selling is not illegal, but short selling with the intention of manipulating the stock price can be illegal as I understand it. Like many financial services companies we have experienced a significant amount of short selling by persons who are anticipating that under current market conditions our stock price will go lower or go down. We continue to monitor the situation but we do not believe that the drop in our stock price can be attributed solely to short selling pressure.

Michelle Debkowski

Another question concerning our stock, the individual was concerned about the recent and continuing decline in the stock price, specifically its rating of four which equates to underperformed market. Is this caused by the continued selling of millions of dollars worth of the bank’s stock by virtually all of the bank’s executive officers during the past year, these comments on this practice, and the message that it sends to our shareholders and the market?

Glenn E. Moyer

We share your (the individual who asked this) concern about the overall decline in all banking related stock prices over the past year or so. The entire sector of financial stocks is out of favor with the general equity market for a number of reasons. We are working hard to keep our fundamentals as strong as possible, especially relative to our fears as we work through this difficult operating environment.

With regard to the comment about sale of stock by bank executive officers during the past year, I can not comment on specifics. What we stay focused on is how well our senior and executive officers meet the stock ownership guidelines established and monitored annually by a committee of our board. In that regard I am aware of only one instance where a member of that group exercised an expiring option and sold the shares. In that case, the option was about to expire and the result in value of the sale was a very modest amount. I believe our executive officers understand and seek to meet our stock ownership guidelines to the maximum extent possible given their unique personal financial situations.

Michelle Debkowski

Thank you, Glenn.

Mike, a couple of questions back to you. Mike, we have received several questions related to unconsolidated investment income, salary and benefit expenses, and non-interest expenses as well as one-time items, but I think that we have addressed previously. But we also received a specific question on the sustainability of these items. Can you comment on that, please?

Michael R. Reinhard

Yes, Michelle. Due to the two acquisitions early this year, providing run rates for core National Penn would not be meaningful. And following our normal practice, we do not plan to disclose specific projected income or expense items for future periods.

Michelle Debkowski

Thank you. And Mike, can you please comment on the reduction in taxes and the tax rate during the quarter?

Michael R. Reinhard

Yes. The reduction in taxes during the fourth quarter is a result of tax return and year end true-ups during the quarter.

Michelle Debkowski

Glenn, a couple of questions for you again on credit and loans, could you comment on the increase in non-performing assets but under providing relative to net charge-off?

Glenn E. Moyer

Michelle, while we did provide approximately $0.69 for every dollar of charge-offs this year, our reserve relative to watch list credits, delinquencies, and non-performing asset coverage remain strong compared to industry averages. And we believe appropriate, given all of the metrics we use to determine the allowance that is required.

Michelle Debkowski

Are the 54 basis points of net charge-offs a good run rate for 2008?

Glenn E. Moyer

No. We expect 2008 to be a 20-25 basis point net charge-offs expense year, which is consistent with our longer term net charge-off rate.

Michelle Debkowski

Glenn, can you provide some color regarding recent results for Christiana and KNBT, particularly asset quality?

Glenn E. Moyer

I don’t have those specifics but my sense is that the areas of challenge for National Penn are similar to those at Christiana and KNBT. As I said, our integration teams are well involved with both companies and I expect a smooth transition based on our shared core values and the clear focus that we all have on the success of our clients.

Michelle Debkowski

Glenn, I will continue with a few more questions on lending. In general how is commercial loan demand?

Glenn E. Moyer

Let me answer that by saying non-real estate commercial loan growth was 7.4% in 2007 and was driven in large part by a very active leverage finance portfolio. We expect 2008 to be similar or slightly down in comparison.

Michelle Debkowski

Glenn, what is the status of the two CI non-accruals that totaled $3.3 million last quarter?

Glenn E. Moyer

I’ve got to tell you, hold on a second here. Let me just see if I can, I don’t know that I have the specifics on that. I’m sorry.

Michelle Debkowski

What does the watch list look like today compared with third quarter? Any concerns with Christiana or KNBT?

Glenn E. Moyer

On that one, actually our watch list is virtually the same as it was in September, basically 3.1% of total loans versus about 3.1% at 9/30 of ’07.

Michelle Debkowski

Mike, have you seen an easing in deposit competition in the fourth quarter?

Michael R. Reinhard

No, we haven’t. It has been a very challenging market with rates remaining sticky high. We will see what recent developments such as today’s rate decrease and last week’s acquisition of Countrywide by Bank of America do to the competitive environment and deposit rates.

Michelle Debkowski

And Mike, how will the acquisition of KNBT affect our interest rate sensitivity and GAAP?

Michael R. Reinhard

We have taken a look at our combined interest rate rest position with KNBT and we believe that there will be no material change to our current position.

Michelle Debkowski

What was the $2.5 million gain from equity in unconsolidated investments? Is this the same as the gain taken in the fourth quarter of 2006 and is it likely to repeat in 2008?

Michael R. Reinhard

As noted in our presentation, this amount is actually less than the $2.67 million recorded in the fourth quarter 2006. As we have said in earlier presentations, the gains from these investments are somewhat recurring but totally unpredictable.

Michelle Debkowski

Thank you, Mike. And one last question for you, Glenn. Who will win the Super Bowl?

Glenn E. Moyer

There you are, you know this is one that I’m closest is a clear forward-looking statement, but I’ve got to go with perfection in New England. But it could be close.

Michelle Debkowski

This concludes our presentation. Thank you for joining us.

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