ESSA Bancorp, Inc. (NASDAQ: ESSA) is one of the best community bank stocks to buy, according to value investing expert Tim Melvin. Despite a strong balance sheet and room to grow, shares are trading at just 85 percent of book value.

To gain a deeper look into the company, Melvin spoke with CEO Gary Olson in an exclusive interview for Benzinga.

Growth

ESSA is in the East Stroudsburg area of Pennsylvania and has been moving up toward Scranton. What’s the economy like in your market right now?

Olson: We have three separate markets. The Pocono mountains, which is our legacy market, has been pretty slow in terms of growth. Not a lot of construction has been going on for many years. The Pocono mountain market was pumped up with folks that were moving from new Jersey and New York City, and all that stopped around 2010.

Immediately to the south of the Poconos is the Lehigh Valley market which is a more vibrant market than what we have here. There’s growth, not growth to the levels we saw, in 2005 and 2006, but that market is growing.

To the North, the Scranton market is marginally better than the Pocono Mountains, but not as strong as the Lehigh Valley.

Over the last few years you’ve been pretty steadily increasing your commercial real estate exposure and decreasing the one to four family category. Are we going to continue to see things move that way?

Olson: Yes we will. Between the interest rate risk and the pricing on one to four family loans and generally the overall size of those loans, we don’t think we can continue to rely on that line of business to grow our $1.5 billion company. We need larger loans that reprice faster than thirty or fixed rate stuff, so we’ve been concentrating on the small business arena. We’ve been hiring lenders and the two banks that we bought brought us some additional growth in the commercial real estate area and some C&I lending. So, we’re going to continue to add commercial lenders and continue to focus on that as a business, both on the lending side and on the cash management side.

Throughout the crisis you held up well. Non-performing assets and difficult loans stayed low. How did your bank avoid stepping on some of the landmines that nobody else seemed able to miss?

Olson; To add even more color, the Monroe county market, which is our legacy market... from a foreclosure standpoint, was probably the most affected market in the state of Pennsylvania. The Federal reserve did a study a few years back there’s a big red dot right on Monroe County.

A lot of people got stung in our market; we did not. We’ve being here for a long time, we have firm underwriting standards that never change, we had a good crew of experienced lenders that knew how to underwrite, we didn’t have any incentives in place that would have our lenders bringing us loans that weren’t going to turn out to be the best loans and ultimately I think we have a philosophy that we don’t set people up to fail. We want to make sure that we do the best we can for our customers and underwrite loans to that standard.

Mergers and Acquisitions

ESSA recently closed the Franklin Security acquisition. Are there more expansions plans looking ahead? Do you see yourself continuing to look for other banks to consolidate?

Olson: When we went public in 2007 we raised about $160 million capital and of course, your shareholders expect you to have a plan for that… We’ve leveraged that capital from 22 percent down to the 10 percent range. To do that, besides paying dividends and buying our stock back, we purchased two banks and continue to look at banks as a way to grow our business profitably. There is nothing [acquisitions] on the horizon, but we’re always interested, we’re always talking and we’re always looking.

So, M&A is part of what we do and I think we’ve demonstrated that we can do it successfully. We’ve bought two banks plus we’ve bought a small insurance agency and we look forward to doing at least one more deal.

New regulation is coming that is going to put some new capital requirements into the industry and certainly we’re part of that. But even with those capital requirements coming we think we’ve got at least one, if not two more deals in this.

Shareholders

Earlier this year you raised the dividend a little bit and you’ve also being buying back stock. Can we expect to see more of that in the future as well?

Olson: We believe at the end of the day, we probably aren’t going to get paid to buy back our stock and increase the dividend. So, we think that we need to continue to grow the business at large and that’s our primary focus. But, in the mean time, with our stock trading at 85 percent of book, we think that that’s a good place to put some capital in terms of buying back stock. We’ll continue to do that when we are not actively pursuing M&A business.

Regarding dividend increases, I’m not sure where we are going. We talk about it at board level all the time, but whether we increase that dividend anytime soon, I’m not sure.

The stock is trading at 80 to 85 percent of book value, you low non-performing assets and plenty of capital, but you are getting little to no coverage from anybody on Wall Street. Are you going to try to talk the stock up or just carry on with business as usual and hope the share price takes care of itself?

Olson: When we went public we had two companies following us: Sterne [Agee] and Stifel [Nicolaus]. As things changed in their companies, they dropped coverage on a number of banks and we were part of that. We’ve had some investment bankers and others that have threatened to begin coverage, needless to say, but they haven’t pulled that trigger yet.

To that end, we use a company out of Lehigh valley, Ambassador Financial, and they have a department in their company that helps us do our press releases and help us communicate our story to institutional shareholders. Earlier this year we went to a conference that they put on in New York City and talked to a number of institutional people there.

I also, talk on a regular basis to, not just current institutional shareholders, but others who are interested in our stock and have questions, and I’m very open to telling our story and getting it out there. So, between myself and what we’ve being doing with Ambassador, that’s how we’ve been getting the story out.

You have very heavy insider ownership of the stock. Your ESOP owns over 11 percent the foundation has about 7.5 percent, and officers and directors have about 19 percent of the stock. Do you feel like this helps everybody at the bank keep better focused on business and underwriting?

Olson: I think one of the reasons that we have that kind of ownership, especially from the insiders, is that we’ve been running a bank that aspires to a higher level of performance, not just financially but from all the risks that we look at. So, regarding credit quality, as I’ve said earlier, we have a philosophy of doing right by our customers and not setting them up to fail with loans that they won’t be able to repay and I think everybody here understands that philosophy… and at 85 percent of book, it probably only goes up form here.

Regulation

The biggest question for anybody in the community bank business is how you are dealing with the large increase in the regulatory and compliance burdens?

Olson: It’s definitely maddening and getting worse.

Between all the new rules that happened prior to Dodd-Frank and for Dodd-Frank which we are only halfway through with what’s going to be implemented, we’ve been adding to staff as a way to stay in compliance. We spend a significant amount of time and have created a new committee in-house. We had a compliance committee before, but we’ve changed its focus to more look at enterprise risk type activities and make sure that compliance is a huge part of that.

We have a couple of bank peers in our locale that have, unfortunately, run afoul of some bank secrecy act issues and we want to make sure that we don’t have those issues. We want to continue to focus on growing our bank and not continue to focus on compliance issues. To that end, we’ll continue to add what we need and continue to spend time internally on compliance issues so that it doesn’t become a distraction for us.

Outlook

You have been with ESSA since 1977 and you have seen many different cycles in the economy. With all that experience in the business, what do you see going forward for community banks in general and for ESSA more specifically?

Olson: When I started, which was three or four years prior to Reagan deregulating the business, there were about 20,000 banks and now we’re just shy of 7,000 banks. Even in our own market, we’ve witnessed a number of banks leaving the marketplace... Again, we have structured the company to be independent for the long term and we actually say that in our values. So, I think the ESSA continues to weather whatever storms might be out there.

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Through four big problems in my career, we’ve seemingly figured out a way to be here to weather all those storms and my guess is that there’s going to continue to be, continue to be some fallout in the industry. There are currently 6,700 to 6,800 banks, and like others, we think there’ll probably be less than 5,000 banks in another ten years or less. People just get tired and boards get concerned that the values continue to shrink and they take their payday while they can and that’s the end of it. Here at ESSA we’re not thinking that way. We think we can continue to grow our business using the model that we’ve built over all these years and we know how to weather the storms and will continue to do so.

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