What Happened
Silvergate Capital (SI -3.70%) fell hard in June, dropping 31.8% for the month, according to data from S&P Global Market Intelligence.
Silvergate Capital is the holding company of Silvergate Bank, which caters to the cryptocurrency industry. Its performance trailed the S&P 500, which was down 8.4% for the month, and the KBW Bank Index, which was down 12.9% in June. Silvergate Capital is down about 57% year to date as of July 7.
So what
Silvergate is one of the leading banks for the cryptocurrency industry through its Silvergate Exchange Network (SEN) -- a real-time payments platform that facilitates crypto trading. As such, Silvergate is closely correlated with the movement of the crypto markets, which have been crashing since late last year.
In early June, Silvergate dropped sharply after Morgan Stanley (MS 0.63%) analyst Manan Gosalia downgraded Silvergateʻs stock from overweight to equal weight because of that correlation.
The decline of crypto assets is well documented. The court-ordered liquidation of crypto-focused hedge fund Three Arrows Capital in late June, after it defaulted on payments, is just the latest example. This news sent most crypto-oriented stocks down with it.
But Gosalia did say in his research note that Silvergate should benefit from the aggressive push by the Federal Reserve Board to raise interest rates. The Morgan Stanley analyst called Silvergate the most "asset-sensitive bank" he covers as it brings in a high percentage of non-interest-bearing deposits through its SEN platform. As Silvergate pays no interest on those deposits, rising rates mean pure profit, which can be invested in other assets. Gosalia said Silvergate has a "30% benefit to net interest income from the first 100-bp (1%) increase in interest rates."
Now what
Silvergate had a lot of foresight to build its market-leading SEN platform and benefited greatly during the run-up of cryptocurrency assets. But unfortunately, it is now caught up in the downturn, even though its revenue numbers have been climbing steadily upward, and its operating margin is 59%. Also, its valuation is extremely low, given its long-term growth potential, with a forward price-to-earnings (P/E) ratio of about 11, down from 45 a year ago.
There is a lot of potential going forward, with interest rates likely to continue to go up for the foreseeable future. It also owns the Diem stablecoin, buying it after its partner, Meta Platforms (META -0.05%), bailed on it earlier this year. And it has a critical first-mover advantage with its SEN platform that should give it a big advantage against current and future competitors. But right now, investors should proceed cautiously given the uncertain conditions in the crypto space.
