For crypto-focused bank Silvergate Capital Corp. (SI, Financial), the last few weeks have been nothing short of a nightmare.
FTX, one of the world's largest cryptocurrency exchanges, went bankrupt in November amid allegations of insolvency from major publication CoinDesk. The bankruptcy of the cryptocurrency exchange is hitting several companies very hard, and Silvergate Capital is no exception.
Silvergate said its exposure to FTX is minimal and total deposits stemming from this area are "less than 10%." The company is fully compliant with all applicable digital asset regulations. It has never had any outstanding loans or investments related to cryptocurrency, nor does it act as a custodian for any of the bank's bitcoin-collateralized SEN leverage loans.
However, there has been a lot of pain for the stock, with the value dropping more than 50% in just one month.
The next few quarters might be painful, but I believe Silvergate will come out of it even stronger. It has repeatedly proven that it is a solid institution, so I have faith in its ability to weather this storm. The stock is now trading near its 52-week low, giving value investors the perfect opportunity to pounce.
Concerns are valid but overblown
The bankruptcy of FTX highlights the fickle nature of the crypto space. For the bears, it is yet another reason not to get involved in the space. Even though the relationship between FTX and Silvergate Capital is limited, investors are punishing the stock nonetheless. The FTX bankruptcy is a reminder that the crypto space is still very much in its infancy and there are still a lot of risks associated with investing in it.
However, there is an argument that the company is being treated unfairly. The bank still has robust fundamentals and a Tier 1 leverage ratio, which was 10.10% back in June. That puts it among the top banks in the U.S. per this metric.
The Tier 1 leverage ratio is a key metric used by financial institutions to assess their financial stability. The ratio provides a snapshot of a bank's overall financial strength by measuring how much Tier 1 capital it has relative to its assets. But the Tier 1 leverage ratio is a bank's Tier 1 capital ratio to its average total assets. Tier 1 capital consists of equity and other high-quality instruments, such as certain loans. A higher Tier 1 leverage ratio indicates that a bank is better able to absorb losses without jeopardizing its solvency.
According to the latest Federal Reserve bank stress test, Silvergate is doing better than most banks in the country for financial health. It maintains its score even with the FTX scandal and many bad loans. For this reason, the Tier 1 leverage ratio is an important tool for regulators and investors when evaluating the health of a financial institution.
Limited exposure to FTX
Silvergate is an FDIC, Federal Reserve and California DFI-approved bank. Even though it is focused on cryptocurrency, it has solid regulatory oversight. The company was one of the first banks to provide services to the cryptocurrency industry and has continued to play an important role in its development. The bank offers a range of services to its clients, including checking and savings accounts, loans and lines of credit. Silvergate has been a leader in developing innovative payment solutions for the cryptocurrency industry.
The company also operates the Silvergate Exchange Network, or SEN, a platform that allows users to buy and sell cryptocurrencies using its banking infrastructure. Silvergate is the only regulated bank in the world to develop a network like this, meaning it has a first-mover advantage. It had 1,677 customers using the SEN at the end of the third quarter and just over $12 billion in deposits.
Silvergate is a unique company because it does not charge clients fees for using its platform. Instead, it benefits when clients bring large deposits on which it pays no interest. Deposits are great for Silvergate to use for bonds or loans. This way, the company can earn money through the interest rate spread. The deposits are a key part of Silvergate's business. It also issues loans against bitcoin, a product called SEN Leverage. Overall, Silvergate is a well-run company that has found a way to generate revenue and earnings without charging fees to its clients. This rare business model is arguably one that should be applauded.
Notably, like most exchanges in the crypto market, FTX is a client of Silvergate. The exchange platform's bankrupcy gives investors and potential clients plenty of cause for concern regarding SEN's outstanding loan portfolio. However, as we have discussed, the exposure is limited. A mid-quarter update from the company confirmed that total deposits have declined to around $9.8 billion, including about $1.2 billion from FTX, which has been built over time.
Silvergate's lack of exposure to FTX and its use of collateralized loans give the bank little reason to believe it will incur loan losses. Additionally, the bank does not have an official lending relationship with FTX. It makes its borrowers set aside enough bitcoin collateral to cover the total amount of their loan and, in some cases, more. Access to customers' bitcoins is limited; Silvergate can liquidate the fund whenever it wants and without having to consult them. It also said in its most recent update it has not yet liquidated any funds, which should give some peace of mind to jittery shareholders.
Takeaway
Silvergate is a cryptocurrency exchange that allows users to buy and sell digital assets. It is one of the few exchanges that is not highly exposed to the FTX bankruptcy, which has caused several other companies in the space to struggle.
Despite this, Silvergate's market value has taken a hit as investors have become more cautious about the future of the crypto industry. As a result, this could be a great opportunity for those looking to buy the stock at a discount and achieve high returns in the future.
