Bank stocks are traditionally thought of as safe, but generally dull, investments. Occasionally, though, you'll encounter a bank that bucks the trend. Even rarer is finding a trend-bucking bank with excellent long-term growth prospects.
Silvergate Capital (SI 0.31%) is one such bank. Its innovation is going after cryptocurrency-focused customers, but what may be even more exciting is how this bank is showing it can weather various market conditions with the help of its multiple income streams. Let's find out more about this top bank stock and why it's a buy-and-hold-forever option for a portfolio.
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Silvergate's primary business now focuses on cryptocurrencies
Silvergate Capital started as your typical bank way back in 1988. But it became atypical in 2013 when it pivoted operations to better serve customers in the little-known cryptocurrency space. The business saw an opportunity to help customers navigate uncharted territory that revolved around Bitcoin and other cryptocurrencies.
One of its early products was the Silvergate Exchange Network (SEN). This network allows cryptocurrency exchanges like Coinbase Global or Gemini to transfer U.S. dollars being used in their exchange systems between one another quickly and efficiently. In the past 12 months, Silvergate has helped exchanges (for a nominal fee) transfer $714 billion in funds. Those transaction fees generated $35.1 million in revenue.
Silvergate's newer product is known as SEN Leverage, and it allows customers to take out a loan using Bitcoin as collateral. The bank has high expectations for this product, which has seen total committed funds grow 428% to nearly $1.4 billion over the past year.
Nations around the world are discussing the adoption of cryptocurrencies as actual currencies with more frequency these days. El Salvador is one recent example with its adoption of Bitcoin as a proper currency in the country beginning last year. The Central African Republic earlier this year has also allowed Bitcoin as a government-sanctioned currency. According to ARK Invest's founder and CEO Cathie Wood, the price of a single Bitcoin could eclipse $1 million by 2030, in part, because of this wider adoption. If that were to happen, Silvergate and its exchange network would be in a prime position to capitalize.
How the bank's earnings grew despite the crypto sell-off
Silvergate sees demand for its services increase when cryptocurrency prices and volume are up, driving higher transaction revenue, as was the case in 2020 and 2021. When there's less activity in cryptocurrency markets, Silvergate's transaction revenue drops off. However, the bank has another way to make money when markets behave like they are today.
This year, volatility across assets has been high, driven by inflation and the Federal Reserve aggressively increasing interest rates to bring it down. This has caused high-risk, high-reward assets like growth stocks and cryptocurrencies to crater in value.
However, Silvergate is managing the volatility well. The bank earns interest income on its deposits and is one of the most interest rate-sensitive banks in the industry. Through the first six months of 2022, Silvergate's net interest income has increased 126% to $121 million.
The reason for the dramatic increase is twofold. The Federal Reserve raised its federal funds rate from 0.25% to 2.5%, increasing interest rates for money in depositors' accounts as well as for lenders in the banking system. But nearly all of Silvergate's $13 billion deposits from cryptocurrency customers are in non-interest-bearing accounts. As a result, the bank reaps the benefits of rising interest rates on its loans, but it doesn't have to increase the amount of interest it pays out on deposits the way other banks do with their accounts.
Image source: Silvergate Capital.
In its recent regulatory filing, Silvergate said another 100-basis-point increase in interest rates would cause its net interest income to go up 16% over 12 months, while a 200-basis-point increase would raise its net interest income by 31%.
This could put a dent in Silvergate's growth
Silvergate is in an excellent position to benefit from changes in interest rates. On the other hand, it could struggle if interest rates start falling and cryptocurrency volumes remain low. Silvergate said a 100-basis-point decrease in interest rates would cause net interest income to fall by 14%. If cryptocurrencies fail to take off in a low-interest rate environment, Silvergate's earnings could be stifled.
Another threat to the business is Signature Bank, which is building out a crypto exchange network of its own. However, I still give Silvergate the edge thanks to its first-mover advantage and stablecoin product, which could power its next phase of growth.
Matthew Gould, CEO and founder of Unstoppable Domains, told Business Insider he could see the stablecoin market growing from $100 billion in 2021 to $1 trillion by the year 2025.
However, regulators have been looking to crack down on stablecoins following Terra USD's crash earlier this year. California recently passed a law that will only allow stablecoins to be issued by an entity that holds a license from the Department of Financial Protection and Innovation or as a registered bank. As a California state-charted bank, Silvergate could be in an excellent position to capitalize as one of the few regulator-approved stablecoins.
OTC: SI
Key Data Points
Investor takeaway
Silvergate Capital has done an excellent job of helping cryptocurrency customers navigate an unknown environment. The bank's diverse revenue stream can help it do well in different market conditions, as it did in the first half of this year. If you're a long-term believer in cryptocurrency like I am, now could be a good time to start building a position in Silvergate to hold for the long haul.
