Silvergate Capital (SI 9.09%) isn't exactly a household name in banking, but it has emerged as the go-to for the banking needs of the rapidly growing cryptocurrency industry. With a client list that reads like a "who's who" of major cryptocurrency exchanges, hedge funds, and other major industry players, Silvergate could be a major beneficiary if cryptocurrency adoption gains momentum.
Two of our banking experts recently decided to take a look at how Silvergate's business works, and whether it could be an interesting investment opportunity. In this Nov. 30 Fool Live video clip, Fool.com contributor Matt Frankel, CFP, and Industry Focus host Jason Moser take a deep dive into what Silvergate does, how it makes its money, and what investors should keep in mind about this unique bank stock.
Jason Moser: Question from a listener recently, Matt. Ben on Twitter (TWTR +0.00%) asks, "Hi Jason, any chance for an industry focus episode on Silvergate Capital. It's a bank that has a platform for cryptocurrency called the Silvergate Exchange Network, the SEN, with a lot of institutional transactions. Thanks. You and Matt make financial discussion interesting." I will say, he concluded that, "You and Matt make financial discussion interesting" with the laugh face, with the little tears of laughter. I mean, maybe that's an LOL. It was a very thoughtful sentiment and it sounds like we're at least doing our job well enough. Let's keep on doing what we're doing, Matt. But Ben, really thank you for the question. I've never really dug into Silvergate before. I'd heard of it. Very small bank, of course. But not too small. I mean, it's just small-cap bank. But an interesting one nonetheless. Looking a little bit more into the Silvergate Exchange Network, particularly, in this age of digital currency, it seems like this is a bank that might become a little bit more relevant as time goes on. What do you think about Silvergate, Matt?
Matt Frankel: Yes. Like you said, they're not a very big bank. They're big enough that we're allowed to talk about them, but not much more than that.
Jason Moser: Around a $600 million market cap, something like that.
Matt Frankel: The Silvergate Exchange Network, which is the most interesting part of the business right now. I was reading that it's a intermediary that it facilitates the transfer of money from one cryptocurrency player to another. That sounded interesting enough. But then I start to read their list of customers and Coinbase is one of their customers, Gemini is one of their customers. The use case is, that normally if a customer buys Bitcoin in US dollars, because when you buy bitcoin, you use money. The exchange would have to transfer that somewhere, then it takes a couple of days. Then it will get transferred to another exchange to buy crypto or something like that. What the Silvergate Exchange does is, it facilitates this 24-7 real-time money transfers between cryptocurrency exchanges and major hedge funds and other digital currency players. There's mining operations that are customers of the bank. It's an interesting case. They have over two billion dollars of cryptocurrency deposits. Most of their deposits are in cryptocurrency, not US dollars, which is an interesting case.
Jason Moser: You square that up to squares balance sheet with 50 million in bitcoin. I mean, that can give you at least some context there as to how big of a role crypto is playing for a company like this.
Matt Frankel: This wasn't always a crypto bank. On their website, it says, they've been profitable for 21 years. So they've been around for at least that long. Their CEO has been there since 2008. They pivoted to crypto in 2013, good timing. There were first to the party it sounds like.
Jason Moser: Perfect timing.
Matt Frankel: Coinbase, Gemini, those are some of the biggest players in the industry that are their customers that they use for their money transfers. It's an interesting industry right now. It's worth mentioning that as a bank, there are two sides to their business. There's deposits and lending. Pretty much the exchange network and the crypto deposits. That's the deposit side. On the lending side, they're mortgage lender. That's interesting. It looks, most of their assets are either mortgage-backed securities or what are called warehouse mortgages, meaning lines of credit to mortgage brokers. They are mortgage lenders. Their loan portfolio is actually pretty high-quality. I saw that their non-performing loan rate is 0.16 percent right now, which is really low if you look at some of the other banks right now.
Jason Moser: That's exceptional.
Matt Frankel: It's interesting. That's how they make their money; a combination of income from their lending portfolio, which is mostly mortgages of a commercial nature. Commercial mortgages and they make fee income from their cryptocurrency activity. An interesting bank. This is not investing in Bank of America (BAC +0.72%) or even one of the smaller more tech-focused banks like we've talked about on the show. It's a play on the cryptocurrency industry. The more money that flows through cryptocurrency exchanges, the more they're going to make.
Jason Moser: I think you summed it up nicely there. I mean, if you look at the way the stock has performed here year-to-date, it was more or less tracking the market up toward October. But starting in October, shortly after they had released their quarterly results, the stock just went, as they like to say, parabolic, man. Just went straight up. Year-to-date stock has returned about 125 percent versus the markets, close to 12 or something. Clearly, Silvergate is having a very good year. I can understand at least and when you're looking through the transcript from the most recent quarter, customers completed over $36 billion in Silvergate Exchange Network transfers during the third quarter alone. Now that exceeded $32 billion that was done all throughout 2019 together. Clearly, Silvergate Exchange Network is gaining a lot of traction and maybe that's the enthusiasm there. I can certainly understand it based on your description of how the company makes its money. I will reiterate, this is a small bank, a 600 dollar million market cap round about. Also worth noting that it has a very low float. There's a low number of shares outstanding, just under 19 million, it looks like. Half of that, essentially, is the float on the open market. My point is anytime you see a small cap bank like that with a low float, you are typically going to see some hefty bid and ask spreads, and you're going to see some pretty volatile movement from time-to-time. It's all to say if it's a bank that you're interested in, this is the kind of bank where I think a limit order probably makes a lot more sense if you're interested in owning it.
Matt Frankel: Yeah, for sure. I would tip toe into this one if you were interested in it.
Jason Moser: Yeah.
Matt Frankel: I prefer it to owning actual Bitcoin as an investment.
Jason Moser: Yeah, I was wondering about that actually.
Matt Frankel: Like that mortgage side of the business should provide nice steady income and then the fee income side of the business is the growth avenue. It's like a nice combination of steady, predictable, recurring revenue and growth potential. But like I said, I like it better than investing in actual cryptocurrency, but like I said, this is not Bank of America or JPMorgan Chase (JPM +1.25%), so I'd be tip toeing cautiously.
