A lot of publicly-traded companies that operate in the cryptocurrency space tend to have shares that closely follow the price of bitcoin (BTC 0.45%), the largest cryptocurrency and the pioneer of digital currencies and blockchain technology. What I mean by that is when the price of bitcoin goes up, so do the associated stocks, and vice versa.
Silvergate Capital (SI +0.00%), a bank that operates in the crypto space, has been clumped into this category as well, which makes a certain amount of sense given its business model. But after seeing Silvergate's second-quarter earnings results, I think there is good reason to believe that the bank's performance, at least on an earnings basis, isn't necessarily correlated with the price of Bitcoin. Here's why.
Image source: Getty Images.
A stellar second quarter of earnings
Several years ago, Silvergate Capital built its own in-house payments system called the Silvergate Exchange Network (SEN). SEN is a payments network that can clear transactions in U.S. dollars any time, 365 days a year, between two users in the network (cryptocurrencies trade around the clock).
SEN is great for the bank, because institutional traders bring large sums of zero-cost, sticky deposits with them, which allows Silvergate to grow deposits quickly and without having to pay interest to the depositors. These deposits essentially serve as a source of free funding that Silvergate can lend out and collect interest on. If you look at Silvergate stock since the beginning of 2020, it has largely traded in line with the price of Bitcoin.
Data by YCharts.
In the second quarter, as the price of Bitcoin fell from a high of $65,000 to below $30,000 at times, Silvergate stock trended lower as well. But results from that period showed the company delivered an outstanding quarter of earnings. Earnings per share (EPS) of $0.80 were up 45% from the first quarter and 176% year over year.
Net interest income, which is essentially the profits made on loans and securities, climbed 32% from the previous quarter as the bank invested $4.5 billion of excess liquidity into securities. It continued to grow its specialized SEN Leverage loan portfolio nearly 32% as well. SEN Leverage is a line of credit in U.S. dollars collateralized by bitcoin. Total volume of more than $258 million represents a more than 10-fold increase from the prior-year period. Another good sign for SEN Leverage is that despite the significant drop in the price of bitcoin, which again is the collateral behind these loans, there were no losses and no forced liquidations. Fee income at the bank came in at a record $12.1 million in the quarter, surging 59% from the previous quarter and up 317% year over year, largely due to increased fee income from digital currency customers.
Solid performance driven by non-bitcoin factors
A lot of the positives that drove revenue in the second quarter were not solely driven by bitcoin. The thing about SEN is it's a network, and you have to be on it to interact with the others, so as the network grows, it becomes more attractive to join. Despite the decrease in the price of bitcoin, Silvergate onboarded 120 more customers onto the network, which is not too far below the number it onboarded in the first quarter. Additionally, while the sheer number of transactions on SEN fell from the first quarter, total dollar volume sent across the network grew 44% sequentially.
Image source: Silvergate Capital Q2 investor presentation.
Silvergate's chief strategy officer, Ben Reynolds, attributed the divergence in the number of transactions and volume to customers keeping more liquidity at the bank through deposits than they needed to actually execute their trades, leading to larger transfers per transaction but fewer overall transfers. Silvergate CEO Alan Lane said the pipeline of potential new digital currency customers for SEN remains "robust."
SEN Leverage also managed to grow nicely in the quarter, despite the pullback in bitcoin pricing. Reynolds said that despite market conditions, the "need for greater capital efficiency" doesn't go away in the digital currency market. He remained optimistic on the future growth of SEN Leverage.
Lane attributed the growth of fee income in the quarter to the fact that there is often a lag between when customers get set up on the SEN network for trading purposes and when they may start taking advantage of other products the bank may offer, such as more traditional ACH transfers or foreign exchange products. Lane said that because of this factor, growth is going to continue to be lumpy going forward, but he feels that overall, the bank is in the early innings of growth.
Another great sign for Silvergate
I have been bullish on Silvergate for a while now, but the surge in profits despite the fall in the price of bitcoin makes me even more confident. While the stock may still move in line with bitcoin near term and earnings may be slightly lumpy, as management said, this recent quarter shows the fundamentals behind Silvergate should enable it to succeed without having to rely solely on the price of bitcoin. As the SEN network gets bigger, it only becomes more attractive for customers to join. Ultimately, I agree with management that the bank is in the early innings of digital transformation and still has loads of potential.
