Shares of the crypto bank Silvergate Capital (SI 10.71%) plummeted nearly 23% on Jan. 18 after the company reported fourth-quarter and full-year earnings results for 2021 that missed analysts' estimates for the first time since the company went public. Silvergate reported diluted earnings per common share of $0.66 on total revenue of nearly $49.3 million, missing consensus estimates of $0.72 earnings per share and revenue of nearly $53.5 million. Is the stock still a buy after the disappointing results? Let's take a look.
Not a bad miss overall
I had initially expected Silvergate to beat on earnings, but after a closer look at the numbers, I do not see a bad overall miss here. Silvergate has created a proprietary, real-time payments network called the Silvergate Exchange Network (SEN), which enables two parties on the network to clear and settle transactions instantly at any day or time. SEN is helpful for institutional cryptocurrency traders and crypto exchanges because the U.S. does not operate on a real-time payments system. As a bank, SEN is great because it brings in digital-asset clients with large sums of non-interest-bearing deposits, on which the bank pays no interest. Silvergate also makes fee income on deposit-related transactions from these customers. In the future, the bank will likely have more fee income opportunities with these institutional and corporate customers by selling them other traditional and new banking products.
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Overall, performance on SEN was solid. Customer growth on the network slowed a bit, with Silvergate only onboarding 76 new clients in Q4, but management said the pipeline heading into 2022 was strong with roughly 300 potential customers. Furthermore, transaction volume on SEN came in at more than $219 billion, which is the network's second-largest quarterly volume.
SEN Leverage, a specialized line of credit collateralized by Bitcoin, saw its volume increase roughly $248 million in Q4, surpassing a total of $570 million, the biggest quarter of growth since the bank introduced SEN Leverage. Despite significant volatility in Bitcoin during Q4, the bank once again had no forced liquidations or losses on the product. Silvergate grew average deposits by nearly $2.1 billion and total period-end deposits finished the quarter at nearly $14.3 billion.
The bank suffered in the quarter due to rising expenses, as salaries and employee benefits grew almost $3 million in the period, as the bank continues to invest in things like its stablecoin infrastructure, which I will talk about later. Net interest income, the profit the bank makes on loans and securities after covering its cost of funding, also seemed to come in lighter than expected as the bank had higher levels of cash and repositioned the securities portfolio to prepare for the Federal Reserve's anticipated interest rate hikes this year.
What's happening with stablecoins?
Many investors went into the earnings call looking for information on Silvergate's initiatives on stablecoins, which are digital assets pegged to a commodity or currency. In the first half of 2021, Silvergate struck a partnership with Meta Platforms, formerly Facebook, in which SEN would be the exclusive issuer of Meta's planned U.S. dollar-pegged stablecoin Diem. Given Meta's audience, the potential market and revenue opportunity looked huge.
But the future of the partnership now seems to be in question. Silvergate management had said it wanted to launch a pilot before 2021 ended. That obviously didn't happen, and other U.S. dollar stablecoin competitors seem to be popping up. Notably, there have been reports that the Fed may launch a central bank digital currency (CBDC) that investors worry could cut into Silvergate's potential share. Additionally, Wedbush analyst David Chiaverini on Silvergate's recent earnings call asked, "With it looking like Diem may not happen, could you talk about your distribution strategy related to the stablecoin initiative if you were to go about it on your own?"
Silvergate Chief Executive Officer Alan Lane didn't exactly address Diem, but he did say that "the way we're thinking about stablecoins hasn't changed." Lane added that the bank sees an opportunity to take the stablecoins beyond digital currency trading and apply them to commerce and remittance. He also said Silvergate does still plan to issue a U.S. dollar-pegged stablecoin that will likely be distributed through existing customers. Lane's hope is to launch something this year. On the matter of a CBDC, Lane said, "we're not concerned about it at all." He thinks if the Fed does this, it would work with the community banking system to issue the CBDC, in which case Silvergate would be extremely well positioned. Furthermore, Lane said a potential CBDC is still "likely years away."
Some of Lane's statements seem to play down the uncertainty regarding Silvergate's stablecoin initiatives. Last year, Lane said management would be disappointed if the company didn't launch some kind of stablecoin pilot before 2022. Now, they are just hoping to launch something this year, so the situation has certainly changed for the worse. However, Silvergate's actions support Lane's comments on the bank continuing to move forward with its plans to issue a U.S. dollar-backed stablecoin. The increase in salaries shows management is investing in creating stablecoin infrastructure on SEN. Lane also noted that the bank in Q4 updated its application with the New York State Department of Financial Services to form a limited-purpose trust company. This entity would be used to help Silvergate manage the reserve deposits backing a U.S. dollar stablecoin in a capital-efficient manner.
The bank also raised $1.3 billion in equity in 2021 and still holds huge amounts of capital. Lane said the bank wants "enough dry powder to take advantage of growth opportunities," one of which could be the stablecoin initiative. If the launch of a stablecoin brings in tons of reserve deposits, Silvergate will likely need to hold enough capital to support subsequent asset growth as part of its leverage-ratio requirement.
Is Silvergate still a buy?
With shares of Silvergate trading at around $97, the bank is being valued at about 210% of its tangible book value, which is what a bank would be worth if it were liquidated. That's certainly high for a regular bank, but Silvergate is not your average bank. Its cost of deposits is effectively zero, which almost no other bank in the world has. It's also adding deposits very quickly and is poised to benefit from rising interest rates. The bank said in its last quarterly regulatory filing that a 1% parallel move in short- and long-term interest rates would increase net interest income by more than 52% over the next year.
It's worth noting that the bank's true returns have been masked by rapid asset growth and equity infusions during the past year. While the stablecoin opportunity is more uncertain and perhaps not as big as it once was, given these other characteristics, I do see the recent dip in the stock as a buying opportunity, although there will likely be continued volatility.
