Crypto bank Silvergate Capital (SI 9.76%) followed up a recent short squeeze with a preliminary update on its fourth-quarter earnings results that sent the stock in the exact opposite direction, plunging to near all-time lows.
Silvergate announced significant deposit outflows in the quarter, big charges from selling bonds, and that it plans to lay off 40% of its workforce. With the crypto market currently experiencing an intense crypto winter and the bank's outlook bleak, is this the end for Silvergate?
Intense deposit outflows
Silvergate Capital is a bank regulated by the Federal Deposit Insurance Corporation (FDIC) but it's quite different from your traditional lender.
Silvergate built a payments network called the Silvergate Exchange Network (SEN) that enables two parties on the platform to transact U.S. dollars in real time. Silvergate doesn't hold any cryptocurrencies on its balance sheet, but SEN is helpful for crypto traders and exchanges because the U.S. banking system doesn't operate in real time, and cryptocurrencies trade around the clock.
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Silvergate allowed crypto exchanges and institutional crypto traders to use SEN for free because these parties would bring large sums of non-interest-bearing deposits to the bank. This served as essentially a free source of funding Silvergate could deploy into bonds or loans and make money on the spread.
But as crypto plunged in 2022 and liquidity began to dry up, digital asset-related deposits began to funnel out of the bank. Then FTX, which had been a big client of SEN (pretty much all crypto exchanges use the platform), filed for bankruptcy and turned the sector on its head. Not only did the FTX meltdown spread contagion through the industry, resulting in many other bankruptcies among clients using SEN, but it also really led crypto participants to pull back.
This in turn led to deposits at Silvergate declining from about $12 billion in the third quarter to roughly $3.8 billion at the end of the year. Everyone expected deposits to decline but this was much more severe than I had anticipated.
Destroying book value
Silvergate maintains an extremely liquid balance sheet, not taking on a lot of credit exposure but mostly investing in government-backed bonds. The problem is most bonds are underwater due to soaring interest rates and Silvergate had to convert many of its bonds to cash in order to cover deposit outflows, which forced the bank to sell bonds at big losses.
In the fourth quarter, Silvergate said it sold $5.2 billion of securities and took a loss of $718 million. Additionally, Silvergate may need to sell more securities in the first quarter, which could result in another loss of $300 million. These are huge when you consider that the bank had shareholders' equity of $1.43 billion at the end of Q3.
Keep in mind that the bank had to mark some of these bond losses to market in the third quarter (the ones it intended to sell before maturity), per accounting rules, so some of these losses may already be accounted for. But even so, these losses are going to significantly destroy tangible common equity, or tangible book value, which banks trade relative to.
Diem now unlikely
One of the exciting parts of Silvergate's future had been the Diem stablecoin initiative. Silvergate in 2022 purchased the Diem assets from Meta Platforms, with the goal of launching a stablecoin that could be used for commerce and remittance.
Silvergate had been investing heavily in the project and it seemed like management was simply waiting for the green light from regulators in order to launch a pilot. But now with so much in disarray, management believes "that the launch of a blockchain-based payment solution by Silvergate is no longer imminent."
As a result, Silvergate wrote down $196 million of the intangible assets it acquired in the Diem transaction. An intangible asset is an asset that is not physical but does carry value such as a patent or copyright. In this case, the Diem technology likely brought intangible value. Intangible assets are typically subtracted from total equity to arrive at tangible common equity.
Is this the end?
I've owned Silvergate for a while now and for much of this time have been quite bullish on the stock, as the bank does seemingly provide critical infrastructure to the sector, so I am obviously quite disappointed. The recent update from management was worse than I had expected, particularly on the deposit outflows.
The outlook for crypto is quite grim and I'm not sure how long it will take for the industry to rebound and for the FTX situation to resolve itself. Silvergate might also face regulatory charges or fines due to its business dealings with FTX -- only time will tell.
On a more positive note, the bank did see about 68% of its deposits leave the bank in Q4, and lived to tell the tale, so that's something. Also, if crypto rebounds then Silvergate and SEN could as well given the service it provides. But with so much uncertainty in the environment and so many other variables, I would not recommend buying the stock right now.
