The crypto bank Silvergate Capital (SI 2.50%) has had a volatile last couple of months, rising to a high of $222 per share in early November and then falling to around $135 earlier this week. Since going public in late 2019, however, the stock is still up about 850%.
The company plans to release fourth-quarter and full-year earnings results for 2021 before the market opens on Tuesday, Jan. 18. With so much volatility as of late, let's look at what to expect from Silvergate's next earnings report.
The Silvergate Exchange Network
Silvergate's business model is powered by the bank's Silvergate Exchange Network (SEN), a proprietary real-time payments network that facilitates trading between institutional investors and crypto exchanges. The network already has more than 1,300 clients, who bring large amounts of deposits that require no interest payments from Silvergate. SEN powers the whole business model, not only bringing in the deposits but also generating fee income because clients use other traditional banking products. Silvergate also is able to originate niche lines of credit collateralized by Bitcoin to clients on SEN, a service called SEN Leverage.
On Silvergate's third-quarter earnings call, management confirmed that volume on SEN is heavily correlated to Bitcoin and Ethereum spot trading volume. If you look at overall spot trading volume on major crypto exchanges in recent months, it shows that volume in the final three months of 2021 was not as high as in some earlier months in 2021, but still should come in higher than third-quarter volume.
Image source: CryptoCompare
Because SEN volume was $162 billion in the third quarter of 2021 and nearly $240 billion in the second quarter, I think it's fair to assume that we'll see volume on SEN come in somewhere between those two figures. Given that crypto spot-trading volume looks closer to volume in the third quarter than the second quarter, I think a more accurate window for SEN fourth-quarter volume is in the $160 billion to $200 billion range.
One variable that could affect my expected range is if a large number of newer clients recently started doing more trading on the network. Also, fee income from SEN clients has so far trended in line with SEN utilization, so I would expect that number in the fourth quarter to fall in between the second-quarter and third-quarter numbers for fee income, which were $11.3 million and $8.1 million, respectively.
Image source: Silvergate Capital Q3 investor presentation.
SEN Leverage loans have been available for only a few quarters, so it's likely those volumes will continue to rise. The deposit story is tougher to predict because even though SEN volume declined in the third quarter, average deposit balances did grow, albeit not at the same pace as in previous quarters of 2021. On the company's last earnings call, Chief Executive Officer Alan Lane said there is a lag between when customers get added to SEN and when they add their funds, so it can take a few quarters until their full deposit amounts come onto SEN. Lane also implied that he thinks deposits will grow from current levels. Deposit growth is important because the more deposits, the more money Silvergate can deploy into loans or securities and reap a return.
The big question for earnings
Analysts on average are expecting Silvergate to generate earnings per share (EPS) of $0.71 for the fourth quarter of 2021 on revenue of $53.4 million. For the full year, analysts on average expect EPS of $2.95 on revenue of $177.4 million. Since going public, Silvergate has not missed on EPS or revenue in seven quarters. Given that crypto spot-trading volumes were trending better in the fourth quarter, I'm expecting a beat. But the big question that will likely be on the minds of investors and analysts is regarding the bank's Diem stablecoin initiatives.
Last year, Silvergate announced a blockbuster partnership with Meta Platforms (formerly Facebook) to be the company's exclusive issuer of the dollar-pegged stablecoin. Given Meta's 2.8 billion global audience, the addressable market is huge. On the last quarter's earnings call, Lane said Silvergate would make money on this partnership through transaction fees when the stablecoins are minted and burned, through interest on reserve deposits pegged to Diem, and by selling other banking products to new customers.
But the project has yet to launch, as far as I know. Before introducing the pilot, Lane said Silvergate was still waiting for the President's Working Group on Financial Markets to release its recommendations pertaining to stablecoins.
The group did release this document in early November. On one hand, I found it positive because it recommended that stablecoins be issued by licensed banks like Silvergate. On the other hand, as pointed out by Wedbush analyst David Chiaverini, the President's Working Group said there "should be limits on affiliation with commercial entities" for stablecoin issuers. While this is just a recommendation, I think it is in reference to a partnership between a stablecoin issuer like Silvergate and a commercial entity like Meta. In other words, if this recommendation were to go into effect, it could limit the scope of the partnership between Silvergate and Meta, but it's really hard to know right now to what extent. Chiaverini also noted that the U.S. is very likely to create its own digital currency, which could eat into Diem's market size. Competitors like PayPal are also launching stablecoins.
I'm excited about Diem, but also nervous. Meta has been trying to do a stablecoin for quite some time and has yet to get it off the ground. I certainly hope that Silvergate's management addresses the stablecoin-related questions on the earnings call. The best-case scenario (and what would likely be good for the stock) is that the company tells us the pilot has launched or will be launching imminently.
