Executive Summary / Key Takeaways

• Hanover Bancorp (HNVR) is executing a strategic pivot, investing heavily in technology and expanding its physical footprint and niche market focus within the competitive New York metropolitan area banking landscape.
• First Quarter 2025 results showed a temporary dip in net income ($1.5 million vs. $4.1 million in Q1 2024), primarily driven by significant non-recurring core system conversion expenses ($3.2 million), masking underlying operational improvements.
• The bank demonstrated accelerated margin expansion, with the net interest margin improving to 2.68% in Q1 2025 from 2.41% in Q1 2024, benefiting from its liability-sensitive balance sheet and recent interest rate dynamics.
• Credit quality metrics improved, highlighted by a decrease in non-accrual loans ($11.7 million vs. $16.4 million quarter-over-quarter) and a substantial increase in the allowance for credit losses coverage of non-accrual loans (196% vs. 139%).
• Strategic initiatives in commercial lending, municipal deposits, the cannabis industry, and adapting loan sale programs are key drivers for future growth and balance sheet diversification, supported by robust capital levels and ample liquidity.

A Community Bank's Strategic Evolution in a Competitive Arena

Hanover Bancorp, Inc., established as a holding company in 2016 for Hanover Community Bank which commenced operations in 2008, operates as a community-oriented financial institution deeply rooted in the New York metropolitan area. Serving a diverse clientele across Nassau, Suffolk, Queens, Kings (Brooklyn), and New York (Manhattan) Counties in New York, and extending into Monmouth County, New Jersey, the bank has built its foundation on providing personalized service and localized decision-making, aiming to differentiate itself from larger, often out-of-market, competitors like major money center and regional banks. This community focus is a core tenet of its strategy, fostering long-standing relationships, particularly within its municipal deposit program, which provides a stable and lower-cost funding base.

The banking landscape in the NYC Metro area is intensely competitive, populated by giants like PNC Financial Services Group (PNC), M&T Bank Corporation (MTB), KeyCorp (KEY), and Truist Financial Corporation (TFC), alongside numerous smaller regional players and increasingly agile fintech lenders. While larger competitors leverage vast scale, extensive branch networks, and sophisticated digital platforms to achieve greater operational efficiency (often resulting in lower operating costs per unit and faster processing speeds), Hanover has strategically chosen to compete by emphasizing its local presence, relationship-based banking, and responsiveness. Management believes this approach offers quicker loan application responses and greater certainty compared to competitors whose decision-making may be centralized elsewhere.

In response to evolving market dynamics and the need to enhance its competitive posture, Hanover has embarked on a multi-faceted strategic evolution. This includes expanding its physical footprint, as evidenced by the opening of the Hauppauge Business Banking Center in May 2023, designed to be a hub for commercial lending and deposit growth, and the planned full-service branch in Port Jefferson, New York, expected mid-2025. These expansions are integral to diversifying the balance sheet and capitalizing on opportunities in areas where the number of commercial banks may be diminishing.

Furthermore, Hanover has ventured into specialized niche markets, notably initiating business banking services for the legal cannabis industry in late 2023, expanding from New York to New Jersey with potential for further state-level growth. This targeted approach allows the bank to serve specific, underserved segments, potentially capturing higher-margin business and building unique expertise.

A critical component of Hanover's strategic response to the competitive and technological landscape is its recent investment in core banking technology. In February 2025, the company completed a conversion to the FIS Horizon core processing system. This was not merely an operational change but a strategic move aimed at becoming a "more technologically advanced, modern and digitally forward-thinking bank." While the immediate impact included significant non-recurring conversion expenses totaling approximately $3.2 million in the first quarter of 2025 (comprising consulting, deconversion, and training costs), the stated goal is to improve the banking experience for clients, streamline internal operations, and drive greater value. Although specific quantifiable benefits of the new system are not yet detailed in the latest report, the strategic intent is clear: to enhance efficiency and service delivery to better compete with rivals who possess more advanced digital capabilities, which can translate to faster processing and lower costs per transaction. This technological upgrade, coupled with a refreshed corporate logo, signals the bank's commitment to modernizing its operations and image to support future growth and competitiveness.

Financial Performance: Navigating Transformation Costs Towards Underlying Strength

Hanover's financial results for the three months ended March 31, 2025, reflect a period of strategic investment and adaptation. Net income for the quarter stood at $1.5 million, or $0.20 per diluted share, a notable decrease compared to $4.1 million, or $0.55 per diluted share, in the same period of 2024. This decline was primarily attributable to a substantial increase in non-interest expenses, which surged by $5.2 million to $15.996 million. The core system conversion expenses of $3.2 million represented a significant portion of this increase, alongside higher salaries and employee benefits ($7.232 million vs. $5.562 million), partially offset by lower deferred loan origination costs and reduced incentive compensation.

Despite the temporary drag on the bottom line from conversion costs, the underlying operational performance showed positive trends. Net interest income increased by $1.7 million to $14.629 million, driven by an expansion in the net interest margin from 2.41% in Q1 2024 to 2.68% in Q1 2025. This margin improvement resulted from a more significant decrease in the cost of interest-bearing liabilities (down 32 basis points to 4.01%) compared to the slight decrease in the yield on interest-earning assets (down 2 basis points to 6.01%). This highlights the bank's liability-sensitive balance sheet structure benefiting from the late 2024 reductions in the Fed Funds effective rate.

Non-interest income saw a modest increase of $0.2 million to $3.732 million, primarily due to higher loan servicing and fee income and other income, partially offset by a decrease in the net gain on sale of loans held for sale ($2.352 million vs. $2.506 million). The decrease in loan sale gains was attributed by management to factors impacting SBA loan sales, including lower premiums and administrative/regulatory delays, but they expect activity to increase throughout the year.

The impact of the increased non-interest expenses, particularly the conversion costs, was evident in the operating efficiency ratio, which rose significantly to 87.1% in Q1 2025 from 65.4% in Q1 2024. This metric is expected to normalize as the one-time conversion costs subside and potential efficiencies from the new system are realized. Income tax expense decreased to $0.2 million (13.8% effective rate) from $1.3 million (24.9% effective rate) in the prior year, influenced by tax benefits from stock option exercises and restricted stock vesting, with management anticipating a normalized rate of 25% for the remainder of the year.

Asset Quality, Liquidity, and Capital Strength

Hanover's asset quality metrics showed improvement in the first quarter of 2025. Total non-accrual loans decreased to $11.7 million (0.60% of total loans) at March 31, 2025, from $16.4 million (0.82% of total loans) at December 31, 2024. This reduction was primarily a result of the strategic sale of $5.0 million in non-performing loans (net of a $0.3 million charge-off). The allowance for credit losses (ACL) as a percentage of total loans increased slightly to 1.17% from 1.15% quarter-over-quarter. More significantly, the ACL coverage of non-accrual loans improved substantially to 196% from 139%, indicating a stronger reserve position relative to non-performing assets. While total loans with Special Mention and Substandard ratings increased slightly to $43.9 million, the overall trend in non-accrual loans and ACL coverage is positive.

The loan portfolio composition remains weighted towards real estate, with residential real estate at 37.4% and commercial real estate (including multi-family and construction) totaling 53.9% of total loans. The commercial real estate concentration ratio decreased to 369% of capital from 385% quarter-over-quarter, reflecting active management. The bank's exposure to the office market is noted as minor ($43.8 million, 2.23% of total loans), with low exposure in Manhattan and favorable debt service coverage and loan-to-value ratios for the pool. A key factor to monitor is the upcoming rate resets and maturities in the multi-family and CRE-investor portfolios, with 31% scheduled in 2025-2026 and 56% in 2027, which will test borrower capacity in the current rate environment.

Liquidity remains robust. Total assets were stable at $2.30 billion. Total deposits decreased slightly by $17.8 million to $1.94 billion. The loan-to-deposit ratio stood at 101%. Core deposits represent a significant portion (73.2%) of total deposits, with the municipal deposit program contributing $517.1 million (26.7% of total deposits) as a stable funding source. Uninsured deposits decreased to $210.9 million (10.9% of total deposits). The bank maintains substantial undrawn liquidity sources totaling $679 million, approximately 322% of uninsured deposit balances, derived from cash, unencumbered securities, and borrowing capacity at the FHLB ($698 million total capacity, $107.8 million utilized) and the Federal Reserve Discount Window ($239.9 million capacity, zero outstanding). Unsecured lines of credit from correspondent banks ($92 million available) provide additional short-term funding flexibility. The bank also utilizes wholesale funding sources like brokered and listing service CDs and ICS deposits, managing interest rate risk on some brokered CDs with interest rate swaps.

Capital levels are strong and exceed regulatory requirements for a well-capitalized institution. Total stockholders' equity was stable at $196.6 million. The bank's Tier 1 leverage ratio (8.95%), Common equity tier 1 risk-based ratio (13.37%), Tier 1 risk-based ratio (13.37%), and Total risk-based capital ratio (14.62%) all comfortably exceed minimum requirements. The tangible common equity to tangible assets ratio was 7.80%. The bank maintains a capital conservation buffer, allowing for continued dividend payments ($0.10 per share declared) and potential share repurchases under the existing program (366,050 shares authorized, none repurchased as of March 31, 2025).

Outlook and Strategic Trajectory

Looking ahead, Hanover Bancorp is focused on leveraging its recent strategic investments and market positioning. Management expects to increase the volume of SBA loan origination and sale activity throughout the year, addressing the factors that impacted Q1 performance. Based on the existing pipeline, C&I lending and deposit activity are also expected to grow as the year progresses, contributing to the ongoing balance sheet diversification efforts centered around the Hauppauge Business Banking Center. The opening of the Port Jefferson branch in mid-2025 will further expand the bank's reach and relationship-building capacity.

The core system conversion, while incurring temporary costs, is anticipated to yield long-term benefits by enhancing operational efficiency and improving the customer experience, crucial elements for competing effectively against larger, more technologically advanced rivals. The successful integration and utilization of this new technology will be key to realizing these benefits and improving the efficiency ratio over time.

While the immediate financial results were impacted by non-recurring expenses, the underlying trends in net interest margin expansion and improving credit quality metrics suggest fundamental strength. The bank's strong capital position and ample liquidity provide a solid foundation to support continued loan growth, manage potential risks from loan portfolio repricing, and execute its strategic initiatives.

Conclusion

Hanover Bancorp is a community bank undergoing a significant transformation. The first quarter of 2025 results, while showing a temporary earnings decline due to one-time technology conversion costs, highlight underlying improvements in net interest margin and credit quality. The strategic investments in a new core system, physical expansion, and niche market development position the bank for future growth and enhanced competitiveness within the challenging New York metropolitan area.

The investment thesis for HNVR hinges on its ability to successfully execute this strategic pivot: leveraging its community-focused model and technological upgrades to drive efficient growth in commercial lending, municipal deposits, and specialized markets like cannabis banking, while effectively managing interest rate risk and maintaining strong asset quality. Investors should monitor the realization of efficiencies from the system conversion, the success of new branch and niche market initiatives, and the performance of the loan portfolio, particularly upcoming CRE rate resets, as indicators of the bank's trajectory towards sustainable profitability and value creation.