In the current macroeconomic environment, it’s really not a very good time to be a bank – interest rates and inflation rising, growth stocks are falling, and fintech firms are capturing a bigger and bigger share of the market every day. It is an even worse time to be a bank dealing with cryptocurrencies – trading volumes associated with BTC and ETH have fallen by more than 30% over the past quarter. However, even in this climate, a certain bank dealing primarily with fintech companies and digital currencies made a killing last week, beating analyst estimates for earnings by 73%. The company in question is Silvergate Capital, which in my opinion is among the most underrated companies in the ARKK ETF.
For context, here’s everything you need to know about their financials:
Stock Ticker: NYSE:SI
Share Price: $111.51
Market Cap: $3.53 billion
Net Income: $24.7 million (up 94% YoY)
In this article, we analyze the primary reasons why I think this company could be a huge difference-maker to the banking industry, and how their business model helps them benefit even in unfavorable economic environments.
For most banks, interest rates going up is usually not a good thing – while they do get to charge higher rates on their loans, they also have to pay out more interest to those that have deposited funds into their checking and savings accounts. However, Silvergate is different – most of their deposits are interest-free, which means that they do not pay any interest on deposits. Add this to the fact that the majority of loans issued by Silvergate are floating-interest loans, which means that they actually make more money on existing loans too as interest rates rise, and you see why this company has positioned itself perfectly for the economic climate.
According to their latest 10-K filing, this is the estimated impact on their net interest income if interest rates were to rise by a certain percentage.
|Interest Rates Rise||Net Interest Income Increase|
Therefore, traditional banks begin losing money upon interest rate hikes because not as many people want loans anymore, but Silvergate shall continue to be profitable.
Silvergate also offers a unique service to institutional customers – it allows them to take out loans using their Bitcoin as collateral. This is a service not many others provide and is a huge source of income for the bank. One of their biggest customers happens to be MacroStrategy, a subsidiary of MicroStrategy, that recently took out a $205 million SEN leverage loan against its Bitcoin holdings in order to buy more Bitcoins. Since the SEN (Silvergate Exchange Network) already includes a wide network of banking institutions, hedge funds, and High Net Worth individuals across the world, there is a demonstrable interest in the SEN leverage service, and loans of this sort are expected to increase in the future. Silvergate has the first-mover advantage in this arena and a pre-existing network of potential clients, in addition to already having around $1 billion committed to the SEN leverage program.
Recently, Silvergate bought the Intellectual Property of Diem Group from Meta Platforms for $182 million in stock and cash, which will be used to further their objectives of building a stablecoin payments network that can serve for cross-border transactions. Currently, cross-border payments between companies are mired with a variety of issues, including but not limited to:
- Delays in payments: Cross-border payments can often take as much as 2 weeks to be processed, which leads to several time delays while conducting business transactions.
- High costs: Payments in different countries are often quite expensive. SWIFT, one of the world’s largest international payments networks, usually charges 3-5% on every transaction in addition to their forex spread.
- FX Risk: Traditional companies that frequently send cross-border payments are also uniquely vulnerable to FX risks, which adds to the operating costs of the company.
- Bank Holidays: In addition to the “8 hours a day, 5 days a week” mode of service that most banks employ, there are several other bank holidays and red days where no cross-border transactions can be carried out, hindering the free flow of business and capital.
Given the latest issues that stablecoins like Tether have faced with regulators and collateralization, Diem’s IP will be a crucial part of running stablecoin infrastructure without such troubles, which is something Silvergate plans to capitalize on. Silvergate CEO Alan Lane said recently, “Through conversations with our customers, we identified a need for a U.S. dollar-backed stablecoin that is regulated and highly scalable to further enable them to move money without barriers.” The initiative is expected to be rolled out later this year when their existing customers will become early adopters and serve as a useful test of how the platform works.
Silvergate’s flagship offering is the Silvergate Exchange Network (SEN), a payment network that allows its members to easily and effortlessly transfer US dollars between different crypto exchanges around the world. It has been a source of exponential growth for Silvergate, with transaction revenues growing at 162% per annum compounded over the last 3 years since the firm started publishing annual reports. The SEN has also been instrumental in allowing Silvergate to boost its digital currency deposits by over 130% simply in 2021.
Silvergate has recently announced in its last quarterly report that they plan to launch a similar offering for the Euro market, called Euro Silvergate Exchange Network (Euro SEN), comprising primarily of crypto exchanges, institutional investors, and hedge funds who have holdings in digital currencies as an asset class. They have several major investors on board for the project already, including Coinbase, Gemini, and Bitstamp.
Cathie Wood’s latest commentary on Silvergate also shows that she’s bullish on the stock, citing their recent growth within the SEN, SEN leverage, the launch of the Euro SEN, and the fact that the bank has also achieved a run rate of a quarter trillion dollars over the past year.
Of course, no investment is free from risks and downsides, and Silvergate is (unfortunately), not an exception to this. Operating in an industry as unregulated as cryptocurrencies, there is always the risk of new government rules and regulations affecting the company’s bottom line.
The Basel Committee on Banking Regulations has recently laid out some guidelines on how cryptocurrency transactions could be structured. For starters, they have declared that Bitcoin does not count as eligible collateral, and this could adversely affect the securities financing and margin loans industry, in which Silvergate is a major player. What this means is that Silvergate would have to set aside more collateral for providing SEN leverage loans, such as the one given to MacroStrategy recently. This shouldn’t really be a problem now, since Silvergate operates ay 47% capital levels, but could become an issue in the future with more loans being given and regulations tightening in the sector.
An additional risk mitigating mechanism that Silvergate has adopted is having an LTV of less than 100% for all Bitcoin loans, which means they have not experienced a single loss or margin call on SEN leverage loans despite the fluctuations in BTC prices.
Another potential risk would be the loss of market share to newer banks in the same sphere, but this also does not seem very likely given that Silvergate has a massive first-mover advantage and a large network of loyal clients through SEN, which would take years to replicate for anyone else.
A Long Haul Underrated Stock
Silvergate Capital continues to be a pioneer and disruptor in the cryptocurrency industry, and analysts across the financial services industry have already given it Strong BUY ratings with price targets ranging from $180-$220 a share. However, none of these numbers accurately capture the innovative potential that Silvergate has, with its stablecoin initiative and work on expanding the SEN. In my opinion (DYOR), this is definitely a strong long-term growth stock that will grow along with the advent of DeFi and cryptocurrencies.