Is Silvergate Capital Facing a Bank Run? | The Motley Fool (2024)

The entire crypto industry has been struggling after the major crypto exchange FTX filed for bankruptcy last week following a liquidity crunch and opening of federal investigations into the actions of its founder, Sam Bankman-Fried.

The crypto bankSilvergate Capital (SI) has been hit particularly hard, with its stock down about 47% since the news about FTX started to break last week. Now there is chatter that Silvergate could be facing a run -- when customers rush to withdraw their deposits because of concerns about the survival of the bank. This in turn can create a liquidity crunch, similar to what happened to FTX, and can put a bank out of business in short order.

The bank run thesis gained steam Wednesday when prominent short sellers Porter Collins, who you may know from the book and movie The Big Short, and Marc Cohodes speculated about this outcome and the bank's future on social media. So, is Silvergate Capital facing a bank run? Here is what I know.

The business model

Silvergate is a bank regulated by the Federal Deposit Insurance Corp., the Federal Reserve, and the California Department of Financial Protection and Innovation.

However, Silvergate mainly operates in the crypto market because the bank has developed a real-time payments system called the Silvergate Exchange Network (SEN). To be clear, neither SEN nor Silvergate holds any cryptocurrencies directly. SEN operates as a payments network for crypto exchanges and institutions to exchange dollars or euros in real-time. This is helpful because cryptocurrencies trade around the clock but most standard banks don't offer real-time payment capabilities.

Silvergate is the first regulated bank to develop this kind of network and therefore has a first-mover advantage. At the end of the third quarter, Silvergate had 1,677 customers using SEN and about $12 billion of deposits. These customers include all of the major crypto exchanges and more than 1,000 institutional investors.

Silvergate doesn't charge clients fees to use the SEN network but it benefits when these clients bring large sums of non-interest-bearing deposits on which the bank pays no interest.

These essentially serve as a free source of funding that Silvergate can use to invest in bonds or issue loans and earn money on the spread. The deposits are essentially what drives revenue and earnings, although Silvergate also issues lines of credit to companies that are collateralized by Bitcoin, a product called SEN Leverage.

FTX and other exposure

FTX was a client of Silvergate like most crypto exchanges, so investors have been worried about deposit outflows from FTX and credit exposure through SEN Leverage. And they were right to be worried to a certain extent. In a mid-quarter update posted from the bank on Nov. 16 after the market closed, Silvergate said that total deposits declined from about $12 billion to $9.8 billion. Baked into that number is the roughly $1.2 billion of deposits from FTX that management had previously discussed.

In terms of SEN Leverage, Silvergate doesn't have a lending relationship with FTX and I have very little reason to believe the bank will incur loan losses. First of all, Silvergate is not overly exposed to these loans. At the end of the third quarter, SEN Leverage had balances outstanding of roughly $1.5 billion, which is less than 10% of Silvergate's total assets. Second, only a little more than $300 million had been drawn down on these credit lines at the end of September.

The other thing is that Silvergate makes its borrowers set aside enough Bitcoin collateral to cover the entire amount of the loan and, in some cases, more. This Bitcoin is placed into a custodial account where Silvergate can simply liquidate it at its own discretion. In the mid-quarter update, Silvergate said it has yet to experience any losses or conduct any forced liquidations of the collateral.

Deposit outflows will be a concern

The big concern continues to be on the deposit side because that is effectively what powers the company's business. SEN really serves the entire industry and Silvergate's 10 largest depositors accounted for about half of the bank's deposits at the end of the third quarter.

Not accounting for the FTX deposits, which were already gone, Silvergate has seen about $900 million of other deposit outflows. There have been reported problems with other exchanges such as Gemini and institutional traders might be getting spooked as well. The issue is that the FTX debacle has really shaken the faith of investors in the industry, especially because a lot of these exchanges are set up abroad like FTX was.

One piece of good news in my opinion is thatCoinbase (NASDAQ: COIN) is a client of SEN. Not only is the U.S.-based exchange regulated as a money transmitter, meaning it holds customer assets 1-for-1, but the company has $5.6 billion of cash and cash equivalents on its balance sheet, so hopefully it's a bit more insulated. Coinbase may also eventually benefit from the demise of FTX by picking up market share long term.

Silvergate was also built to deal with the volatility, and as a result it has a highly liquid balance sheet. At the end of the third quarter, the bank had nearly $1.9 billion of cash and cash equivalents and another $8.3 billion of available-for-sale securities that can be quickly converted into cash. As a federally regulated bank, Silvergate could also tap the Federal Home Loan Bank or the Federal Reserve if it needed help with liquidity.

A bank run is unlikely

The FTX meltdown obviously is a huge concern, largely because we just don't know the extent of any contagion.

I think a bank run for Silvergate would be very unlikely but I do expect Silvergate to continue to see deposit outflows (which it has been seeing all year) in the near term that will hurt earnings -- the stock has already seen some significant earnings revisions. Interestingly, KBW analyst Mike Perito said Silvergate could lose $7 billion in deposits before its book value begins to erode (there's already been $2.2 billion of outflows).

Silvergate's book value per share at the end of the third quarter was almost $36 and the stock currently trades below $30 per share, so this tells me investors are baking in heavy deposit outflows into the share price.

The situation is very dicey. There is likely to be some pain but ultimately I believe Bitcoin and crypto trading are here to stay, and that Silvergate is as well because it provides the industry with a critical service.