An Energetic Banking Strategy

 | Jan 16, 2013 | 2:00 PM EST
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A brief email exchange a couple of weeks ago planted a thought in my head that has stayed with me. Although I do not invest based on demographic, economic and social trends alone, I do stay aware of them and will look for cheap stocks that fit within certain themes. I keep lists of various segments, such as infrastructure stocks, and check them from time to time to see if any of the names have become safe and cheap enough to buy. I never act until they reach my valuation levels, but I am aware that these trends could easily be catalysts for higher prices.

Two trends can be combined in our search for long-term profits. The first is energy in general -- and natural gas in particular. The U.S. has an excess of natural gas right now because new technologies have allowed us to more efficiently explore and develop unconventional sources. Fracking and extracting shale gas are going to be a huge part of our national energy solution for many years to come. Although it may be more politically correct to focus on wind and solar energy, it is going to be more profitable to focus on fossil fuels for the next decade or two. Our economy needs cheap fuel, and the best and most abundant source right now is natural gas.

The second trend is my "trade of the decade" in regional and community banks. The credit crisis took a toll on the shares of smaller banks, which struggled to deal with loan losses on every classification of lending. They have fallen to the lowest valuations since the early 1990s savings-and-loan crisis. The aftermath of that debacle led to bank stock prices rising over the next decade by a factor of 10, and I expect to see the same activity over the next 10 years. Banks that are seeing growth in deposits, lending and profits from oil-and-gas activity could see even more rapid appreciation due to the strong economic activity in their region.

I will begin our combination search with the Bakken fields in North Dakota and Montana. According to the statistics recently released by the Minneapolis Federal Reserve Bank, the oil boom in that region is rapidly creating wealth. Unemployment in the region is below 2%. The average wage is increasing and is now one of the highest in the country. Retail sales are growing and housing demand is rising. The banks are seeing strong growth in both deposits and loan demand. This is stark contrast to what we are seeing in many other areas of the country.

One of the largest banks in the Bakken region is my old favorite, First Interstate Bancorp (FIBK) of Billings, Mont. I have owned the stock for some time now based on  its valuations in 2010 and 2011, and I have no intention of selling. The bank has been growing right along with the oil boom and shareholders' equity has grown from $444 million at year-end 2007 to almost $800 million today. The bank is the deposit market share leader -- not just in Billings, but in the entire state of Montana. Nonperforming assets have been declining rapidly as the region's economy benefits from the oil boom and are now just 2.72% of total assets. The shares trade at 1.1x tangible book value, so this is likely a good time to buy some shares and average down in a market decline.

Glacier Bancorp (GCBI) of Kalispell, Mont. also has a strong presence in the Bakken region. The bank is second in market share in Billings and the rest of the state. Glacier has 11 different community banking divisions that retain the local name and presence throughout the region. In addition to its strong presence in the oil region, the bank also has a strong agricultural base throughout its service area. The bank has adequate capital with a tangible equity-to-asset-ratio of 10, and the loan portfolio is improving rapidly. The shares currently trade at 1.23x tangible book value, so you will need some patience with Glacier. I would be a buyer of the shares below tangible book value in a market decline or news-driven selloff in the stock.

Combining these two powerful economic trends makes a lot of sense to me. Consumers are going to expand our use of domestic oil and natural gas in the U.S. over the next decade. Banks in the regions that produce oil and gas will see strong growth in deposits, loans and, hopefully, profits. Right now, the regional and community banks with energy exposure are as cheap as their brethren around the country. I think it will be a profitable use of our time to find banks in energy rich regions that are safe and cheap.

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