Cryptocurrency markets have been under pressure this year, and the collapse of FTX has only made things worse. Many crypto-related stocks are taking a beating in recent weeks due to the fallout from FTX's filing for bankruptcy protection. One stock feeling the pressure is Silvergate Capital (SI 2.50%), a bank focused on serving cryptocurrency customers.
Silvergate looked to calm fears when it told investors it had limited exposure to FTX in terms of deposits and loans. However, its stock has declined about 70% since mid-September as investors remain concerned about its exposure to other struggling companies in the crypto industry. While Silvergate faces risks, things may not be as bad as it seems.
Silvergate has carved out a niche in the banking industry by focusing on crypto
Silvergate Capital provides banking services to customers in the cryptocurrency market, helping them navigate uncertain regulations and move money.
Its primary product is the Silvergate Exchange Network (SEN), which allows cryptocurrency exchanges like Coinbase Global, Binance, and Gemini to transfer U.S. dollars from one another quickly and efficiently. This year Silvergate has helped customers transfer more than $446 billion in cash, collecting $25.6 million in transaction revenue as a result. Transaction fees from this network make up about 11% of Silvergate's total revenue.
An even larger portion of Silvergate's revenue comes from net interest income, or the difference between the interest it earns from its loans and the amount paid out on deposits. Most banks have a mix of interest-bearing deposits and noninterest-bearing deposits. Silvergate is different, with over 99% of its total deposits being noninterest-bearing. As a result, the bank is highly sensitive to today's rising interest rates, which increases interest income significantly without causing interest expense to change very much.
Falling crypto prices pose this risk to Silvergate's business
One crucial risk to Silvergate's business today is its shrinking deposit base. The bank relies heavily on its low-cost deposits, and a decline in deposits reduced its capacity for lending, investing, and other banking services.
At the end of 2021, its total deposits amounted to $14.3 billion -- and it was in an excellent financial position to capitalize on higher interest rates. However, falling cryptocurrency prices have reduced noninterest-bearing deposits, which declined to $12 billion by the end of the third quarter.
Following the fallout from FTX, Silvergate management eased investor concerns, saying that FTX accounted for less than 10% of its total deposits. As of Nov. 16, Silvergate's deposit base for crypto customers, excluding FTX and related companies, fell to $9.8 billion.
Silvergate also offers loans using Bitcoin as collateral through its SEN Leverage program. SEN Leverage loans as of the third quarter were about $1.6 billion, less than 10% of Silvergate's total assets. Not only that, but Silvergate requires borrowers to put down collateral equal to (or more than) the entire amount of the loan, and it can liquidate any positions at its own discretion. The company said that FTX didn't have any of the loans and that all of these loans have performed thus far with no losses and no forced liquidations.
The bank stock looks like a bargain trading below book value
Silvergate Capital stock had a huge run-up when Bitcoin prices exploded, so it's not surprising to see it come back down. What is surprising is just how cheap it has gotten. The bank is near its cheapest valuation since going public, with a price-to-earnings ratio of 6.7 and below book value at 0.69. It's also on strong financial footing, with nearly $1.9 billion in cash and cash equivalents and $8.3 billion in available-for-sale securities that could be sold quickly if necessary.
SI PE Ratio data by YCharts
However, short-term headwinds will still weigh on the bank. BlockFi's recent Chapter 11 bankruptcy filing was another blow as fallout from the FTX debacle unwinds. Although BlockFi's deposits are only $20 million of Silvergate's total deposits, concerns about contagion in the crypto market have put selling pressure on any crypto-related stocks and will likely weigh on the bank in the near future.
Silvergate is an appealing stock at its current valuation and looks like an excellent buy if you believe in Bitcoin for the long term and don't mind dealing with volatility in the near term.
