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Crazy Deposit Growth Masked an Unbelievable Quarter for Silvergate Capital

By Bram Berkowitz - May 11, 2021 at 7:37AM

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The huge deposit growth ballooned the balance sheet, while the bank also raised equity in the quarter. Both events dampened some key profitability metrics.

The crypto bank Silvergate Capital (SI -1.73%) had a remarkable run in 2020, generating strong earnings and huge stock price appreciation as several years of hard work investing in the right infrastructure and technology really began to pay off. The bank kept the momentum going in the first quarter of 2021, generating a profit of $12.7 million, which is equivalent to a 0.71% return on average assets (ROAA) and a 9.76% return on average equity (ROAE).

Those numbers are not bad by any means, but for a bank that currently trades around 340% tangible book value, they do mask how truly remarkable of a quarter Silvergate really had. Here's why.

Massive deposit growth

In case you are not familiar, Silvergate is not your typical bank. Silvergate noticed several years ago that cryptocurrencies like Bitcoin (BTC -1.73%) would one day be an investable asset, so the bank built its own in-house payments system called the Silvergate Exchange Network (SEN). SEN is a real-time payments network that can clear transactions in U.S. dollars instantly around the clock, 365 days a year, between two users in the network. This is ideal for institutional crypto traders and crypto exchanges because cryptocurrencies trade around the clock.

The SEN network is also ideal for a bank because institutional traders bring large sums of zero cost, sticky deposits with them, which is why the bank has an entire deposit base that it actually -- not exaggerating here -- pays no interest on. Even in this kind of low-rate environment, that is simply remarkable.

As crypto has become more and more integrated into the mainstream financial system, more institutional traders have sought to gain exposure and joined SEN because it is ahead of the game. During the first quarter, Silvergate onboarded 135 new clients and the bank grew average deposits from roughly $2.8 billion at the end of 2020 to roughly $6.6 billion at the end of the first quarter.

Picture of digitized outline of a bank.

Image source: Getty Images.

This kind of growth has ballooned the bank's balance sheet to roughly $7.2 billion in assets and distorted several key metrics. Let's say average assets had instead landed at $5.2 billion at the end of the first quarter, which is still tremendous growth from the $3.2 billion in deposits the bank had at the end of 2020. The return on assets would have been nearly 0.98% ROAA ($12.7M x 4 to annualize/$5.2B assets), significantly higher than the 0.71%. The huge balance sheet growth also significantly hurt the bank's net interest margin (NIM), the difference what banks pay on interest-earning assets such as loans and payout on interest-bearing liabilities such as deposits. Silvergate's NIM dropped from 2.85% at the end of 2020 to 1.33% at the end of the first quarter. That's a huge drop but only because the bank now has so many assets earning such little yield.

Silvergate also raised capital during the quarter to support future growth at the bank. That increased the bank's average shareholder's equity from nearly $288 million to $528.3 million, which is of course why the strong quarter only resulted in a 9.76% ROAE. Had the bank still had the $288 million in shareholders equity at the end of 2020, it would have reported somewhere around a 17.5% ROAE ($12.7M x 4 to annualize/$288M). Now, successfully raising capital at the valuation that Silvergate did and bringing in all these deposits are both great things, but this just shows how good of a quarter Silvergate really had.

Well positioned

Although the price has dipped significantly this past month, I still see all sorts of growth and earnings potential at the bank. For one, management on the company's recent earnings call seemed optimistic about its pipeline of potential SEN customers, and SEN transfers continuing to grow.

Silvergate Capital Customers and SEN Utilization charts.

Image source: Silvergate investor presentation.

Second, after all of the spectacular deposit growth, Silvergate's loan-to-deposit (LTD) ratio sits at a measly 23%, meaning it has only deployed 23% of its deposits into loans. Normally, you would not see a bank with a 23% LTD ratio, but in this case, deposits have simply grown far too quickly for loans to keep up with, especially in this kind of high-liquidity environment. However, this leaves substantial earnings to harvest from the balance sheet. I don't think Silvergate will get anywhere close to 100% LTD, maybe ever, and the bank is probably wondering how much of these deposits will stick around long term. But needless to say, the bank will not be limited by loan demand anytime soon.

The good news is the bank is likely to see more loan growth from its unique SEN leverage product, which only came out of pilot mode a few quarters ago. SEN leverage is a line of credit in U.S. dollars collateralized by Bitcoin, and it gives Silvergate's institutional clients more capital efficiency and ability to gain leverage, as they trade other asset classes as well. At the end of the first quarter, SEN leverage volume had reached more than $196 million, up from around $83 million in the previous quarter. So far, Silvergate management says that only about 10% of the bank's institutional clients are using the product. They think that eventually 80% of these clients may be interested, so there's tons of loan growth potential.

Buy the dip

Given the great quarter the bank had and the tremendous growth and earnings potential, I would recommend investors buy the recent dip in the stock. I actually did myself recently. The huge balance sheet growth and stock offering slightly masked a superb quarter. While Silvergate's stock will likely move a little bit with the prices of digital assets like Bitcoin, it offers a more stable model because the bank is still just deploying deposits it brings in at no cost into more traditional-yielding assets. Institutional funds are also a lot more stable than those from consumers.

While still volatile, I believe cryptocurrencies will have a permanent place in the mainstream financial system, and Silvergate is currently in one of the best possible positions to serve institutional clients looking to trade the digital assets.

 

Bram Berkowitz owns shares of Bitcoin and Silvergate Capital Corporation. The Motley Fool owns shares of and recommends Bitcoin. The Motley Fool has a disclosure policy.

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